How to Invest in Canadian Utility Stocks via ETFs

After exploring ETFs for Canadian banks and energy companies, we turn our focus to the utility sector, a cornerstone of defensive investing alongside consumer staples and healthcare—the latter being scarcely represented on the TSX.

Utilities are often considered a defensive sector due to their lower beta and the essential nature of their services—regulated utilities, for example, provide stable, evergreen demand.

However, it's a sector that's not without its risks. In 2022, utilities felt the pinch as interest rates rose, impacting their heavily leveraged balance sheets. A noteworthy example was Algonquin Power & Utilities (AQN), which became a cautionary tale during this period.

With the Bank of Canada having recently lowered interest rates thrice by 0.25% each time, utility stocks are positioned to potentially outperform other sectors, offering attractive yields in the process.

In today's guide, we'll explore the primary ETFs providing straightforward, long-only exposure to Canadian utility stocks, setting aside the "enhanced" options—those involving leverage, swaps, inverse exposure, or strategies like covered calls—for another discussion.

iShares S&P/TSX Capped Utilities Index ETF (XUT)

If you're considering utility stocks within the S&P/TSX Composite Index and prefer a more focused approach, XUT might catch your eye.

XUT market-cap weights the 15 utility stocks from the TSX, each capped at 25% to avoid any single stock dominating. Since its launch in April 2011, XUT has grown to manage just shy of $300 million in assets.

The ETF includes top Canadian utility players like Fortis, Brookfield Infrastructure Partners, Hydro One, Emera, AltaGas, and Brookfield Renewable Partners. These companies span various segments of the utility sector, including electric, gas, hydro, and renewable energy infrastructure.

However, the TSX utility sector's limited scope results in a concentrated portfolio for XUT, featuring only 15 holdings. This makes the ETF top-heavy—Fortis alone makes up over 23% of its weight, followed closely by other major players, which could be a concern for those seeking broader market exposure.

One notable downside is its expense ratio of 0.61%, which is steep considering the ETF's narrow focus. This might lead some investors to bypass XUT in favor of directly investing in its top holdings.

Despite these drawbacks, XUT remains an attractive option for income investors, offering a generous 5.7% distribution yield. This yield is calculated by annualizing the most recent payment and dividing it by the ETF’s share price, with distributions paid monthly, ideal for those looking for steady income.

BMO Equal Weight Utilities Index ETF (ZUT)

XUT has a cap of 25% per company to tackle concentration risk, but if you're looking for a broader spread across the utility sector without overemphasis on any single company, ZUT might be more up your alley.

This ETF adheres to the Solactive Equal Weight Canada Utilities Index, ensuring each of its 14 holdings is balanced equally at every rebalance. It pretty much holds the same stocks as XUT does.

ZUT is actually heftier than XUT, boasting an AUM of $444 million. The equal-weight strategy it employs does add a bit more risk due to the higher emphasis on smaller-cap stocks, which could mean more volatility but also potential for greater returns.

Like XUT, ZUT offers a decent distribution yield of 4.27% with monthly payouts. However, it shares the same drawback of a high 0.61% expense ratio, which is steep given its straightforward strategy.

Global X Canadian Utility Services High Dividend Index ETF (UTIL)

Rounding out today's discussion is UTIL, a relatively new entrant in the Canadian utility ETF market, having launched in August 2022 and current has just over $14 million in assets under management.

This ETF follows the Solactive Canadian Utility Services High Dividend Index, which currently allows it to offer a distribution yield of 4.44% with monthly payments.

Unlike XUT and ZUT, UTIL expands its scope beyond traditional utilities to include pipelines and telecoms, adding midstream energy and communication services to its portfolio.

This modern approach to classifying utilities encompasses not just regulated sectors like gas, water, electricity, and renewables but also integrates key infrastructure players such as TC Energy, Enbridge, and Pembina, along with major Canadian telecoms like Rogers Communications, BCE, and Telus.

Despite its broader scope, UTIL charges the same 0.61% expense ratio as ZUT and XUT. While this fee is on the higher side, UTIL's more expansive sector coverage might justify the cost for investors looking for a more diversified utility play.