Defensive utility company shares have traditionally been the bedrock of investors' portfolios. But, so far this year, the sector has underperformed the wider market by approximately 25 per cent. The FTSE 350 Gas, Water & Multi-Utilities sector and the FTSE 350 Electricity sector have been the second and third worst performers. Does that make them cheap, or is there a good reason why investors are pulling the plug?
Once regarded as a dull-but-reliable investment, the predictable staying power of utilities stocks has caused investors to champion them as a long-term income play. The regulated nature of the industry gave the added advantage of reliable forecasts of dividend returns.
In the current economic environment, utility stocks boast qualities that should be attractive to an investor in an uncertain world. But the recent levels of sustained underperformance have come as a shock to those expecting a slow-but-steady ride. So what exactly does the market have against the utility stocks? The answer can best be surmised as the politicisation of the utilities sector.
Investors chose utility stocks because they like certainty. But there are increasing amounts of uncertainty on the horizon, ranging from the basics of supply and demand, to the future impact of environmental legislation. And one of the few certainties? The massive amount of investment needed to fund green energy obligations – a cool £264bn by 2025, according to independent think tank Policy Exchange.
Ultimately, equity investors will be expected to fund this, in the form of renewable energy plants, new-build nuclear and carbon-capture storage, not to mention the upgrading of supply networks. And the biggest uncertainty? The returns they might expect to achieve on such a substantial investment, given the current lack of clarity from government.
The water stocks face a separate set of problems – regulator Ofwat's final determination of price controls for the next five years is due at the end of November, and it is going to be harsh. Water stocks started to plunge when the draft determination was released this summer, propelled downwards by fears of rights issues and expected dividend cuts.
