The Loy Yang Power Station. Photo: Paul Jones
In a year of unlikely winners, it should perhaps come as no surprise that the best performing sector in the local market has been the humble utilities sector.
These companies have traditionally been valued for reliable dividend yield and boring (or steady, depending on your point of view) underlying business models; some even have their revenue regulated by government authorities, hardly the stuff to get an investor's pulse racing.
Yet the sector has been running hot in 2014.
On Bloomberg numbers, the utilities sub-index of the S&P/ASX 200 is up 10.5 per cent this year – and that's price appreciation alone.
As the attached chart shows, the benchmark index as a whole is up a paltry 2.6 per cent. Resources have gone backwards, banks managed around the index return, and industrials – that broadest of conglomerations – has added 3.8 per cent.
The next best performing sector are listed property trusts, up 8.1 per cent.
The Australian real estate investment trusts (or A-REITs) were chastened and then reformed following the excesses of the pre-GFC era, and are reaping the benefits of being boring yield plays once again.
At the root of it all has been government bond yields. Last year investors were terrified of rising global interest rates. This year it's been the reverse.
The yield on the local 10-year government bond was 4.4 per cent in the first week of January. Last week it reached a low of 3.7 per cent – a big move in the staid world of AAA-rated government securities.
And there's no sector in the sharemarket more sensitive to bond rates than utilities, which are seen as an attractive option for the yield-hungry investor who is no longer getting the yield they need in fixed income.
The second chart shows the relationship between the Aussie 10-year government bond yield and the S&P/ASX 200 utilities index. You can see that they move broadly in opposite directions – and that this inverse relationship has been particularly distinct since December when the world really started to get a sniff of a near future where global rates went lower, not higher.
"Regulated utilities have outperformed because the market has been hungry for yield," says UBS analyst David Leitch. "If global bond yields continue to decline then the sector will continue to attractive."
"Regulated" utilities are so-called because they have a fixed asset base which gives you a guaranteed return. That makes them particularly attractive to superannuation funds, the liabilities of which tend to increase at the same rate as the government-mandated growth in utilities' revenues.
Such stocks include SP Ausnet, Spark Infrastructure, APA Group, Envestra and DUET Group – the last of which is Leitch's top pick in this space.
"DUET has a yield of about 7.5 per cent, and we're reasonably confident that their distribution won't be lower in the coming two or three years," he says.
In fact, Leitch expects DUET's "distribution to grow 2.5 percentage points per year for each of the next three years".
Compare that to an iron ore stock, which may look cheap now, but what will its earnings look like in 2017? It depends heavily on what happens in China – and the uncertainty around the economic trajectory of our largest trading partner is another factor driving investors into the arms of "boring" stocks.
The management of utilities companies themselves also appreciate that their businesses are particularly well sought after, both locally and globally. That is driving a growing trend for industry consolidation, which is also boosting share prices.
Last Tuesday Spark Infrastructure announced it had taken a 14.1 per cent in DUET Group. APA Group put in a scrip offer for gas distributor Envestra, only to be dragged into a takeover tussle with Cheung Kong Infrastructure, after the Hong Kong company lobbed in a last-minute cash bid.
Can utilities continue to outperform? It's hard to see global bond yields not moving higher over the coming three or four years, which is bearish for share prices. At the same time, a low growth environment should keep rates below their historical averages, maintaining the attraction of utilities on dividend yields of 6 to 7 per cent.
Consolidation in the industry is also likely to ramp up rather than down. There's no evidence that the world's pension and sovereign wealth funds' appetites for long duration, reliable assets is waning.
So while there may not be another 10 per cent return ahead for utilities investors over the next five months, but expect boring to remain exciting for some time yet.