- The Washington Times - Wednesday, October 16, 2002

Battered by volatility and poor performance from utilities shares, several mutual fund companies are turning away from funds concentrated in electricity, water and telephone companies, once a safe haven for slow, steady growth.
The Vanguard Group, the nation's second-largest mutual fund company, is asking shareholders in December to approve replacement of its Vanguard Utilities Income fund to the Vanguard Dividend Growth fund, which would focus on dividend-paying companies from different industries.
Shareholders at First Investors will vote later this month on whether to change the company's utilities fund to the First Investors Value fund. And Strong last year replaced its no-load American Utilities fund with the Strong Dividend Income fund.
"The utilities industry, and what we considered the utilities sector, has changed so radically from the fund's inception in the early 1990s," said Jeffrey Molitor, Vanguard's director of portfolio review.
"What used to be considered widows-and-orphans' stocks has evolved to a highly volatile and non-regulated set of entities with much less focus on dividends and a greater focus on growth," he said. "They just pose a lot more risk."
Ten years ago, safe-haven investors relied on the government-regulated utility companies to provide a steady income of generous dividends. But deregulation in many states, starting in 1996, changed that.
Many telephone and electric companies lost their monopolies, and branched out into riskier ventures, such as electricity trading and high-speed Internet access. In the process, many took on debt and trimmed dividends.
Accounting scandals at Enron Corp. and WorldCom Inc. this year also helped decimate stocks, hurting utilities funds' performance.
This year, the funds lost 29.2 percent on average, according to fund tracker Lipper Inc. Over three years, utilities funds averaged a loss of 12 percent, while five years ago, they declined about 1.9 percent.
Total assets in utilities funds through August dropped to $13.7 billion, down from $20.4 billion at the end of 2001.
"Mutual fund companies are switching because their utilities funds have done much more poorly than expected," said Paul Herbert, an analyst at Morningstar Inc. "When other funds are doing poorly, utility funds were expected to do better, and they certainly haven't."
Mutual fund managers fear that it could take years for the industry to stabilize. The unregulated entities are in flux due to overcapacity and high debt, while state-regulated companies need to strengthen their balance sheet, said Justin McCann, Standard & Poor's electric utilities analyst.
"Utility companies have to regain investor confidence," he said. "Things are just up in the air in terms of whether deregulation is going to slow, whether energy trading is going to come back or be much more regulated, and how much overcapacity there is in terms of plants being built."
Still, analysts say investors shouldn't necessarily rush to abandon utilities funds, so long as they realize that many of the funds' roles have changed to "a bet on an industry much like a different sector fund."
"The funds aren't going to play the same role that investors had once expected them to in their portfolio that is, performing well when other stocks haven't and providing a dividend payout," Mr. Herbert said.
At the same time, some utility funds remain promising, because they continue to focus on state-regulated electric companies with good dividends, Mr. Herbert said, citing in particular Franklin Utilities, one of the sector's top performers.
The fund, which looks for companies with strong balance sheets, low growth earnings projections and a large percentage of earnings in regulated businesses, had the smallest loss in the sector this year, declining 15.21 percent. Over three years, it returned 1.5 percent; over five years, it gained 2.9 percent.
"Investors need to differentiate to identify which ones of those companies haven't really strayed the course and have maintained their traditional franchise," said John Kohli, manager of Franklin Utilities.
"We still think there's going to be a lot of negative surprises, but if you tread carefully, there are also a lot of great opportunities," he said.


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