Time for investors to rediscover utilities?

Real asset class could play a role amid backdrop of falling inflation, rising recession risk, and thematic trends

Time for investors to rediscover utilities?

While the utilities space has suffered some of its worst years of underperformance amid rising rates and narrow market breadth, that could set the scene for greater opportunities in the coming years.

That’s according to a recent note from Stephen Bonnyman, VP, portfolio manager and head of Equity Research at AGF Investments.

“The global Utilities sector now trades at some of its lowest observed multiples in many years (relative both to itself and to the broader market), even though margins and earnings for the group are improving,” Bonnyman said.

It’s not just utilities that are looking more reasonably priced. Following the inflation and interest rate movements of the past year, he sees many instances where real assets – commodities, real estate, infrastructure, and utilities – are “currently available at undemanding valuations.”

Read more: The benefits of real assets amid inflation uncertainty

With the low rates of the past decade unlikely to return, inflation possibly turning out to be more stubborn than anticipated, and increasing prospects of recession, he says investors might be driven to seek investments with stable and growing yields, lower earnings volatility, and lower correlation to the broader market.

“The largely capital-intensive Real Asset universe has broadly suffered from a lack of reinvestment funding over the past decade, which has allowed increasing pricing power to incumbent providers and created the potential of new opportunities for greenfield and brownfield investment,” he said.

Traditionally, Bonnyham said utilities have tended to outperform in periods of falling inflation and declining rates. The potential for robust earnings, solid balance sheets, and stable dividends could push investors to rekindle their love affair with the group.

Read more: Do peaking interest rates mean good times for utilities stocks?

“While often forgotten, Real Assets also form the backbone for most of the thematic developments that dominate the existing news cycle,” he added.

In the years ahead, he argued real assets will be instrumental in energy pricing and scarcity; the reliance of electric vehicles on metal commodities such as lithium and nickel; the need to generate and create a stable grid for renewable energy; the AI revolution, which would entail unique power requirements and data centres; and the ongoing challenge of food sustainability.

“In short, an actively managed allocation to Real Assets may prove critical to investment performance over the next cycle, allowing investors to both participate in emerging trends and protect their portfolios from near-term economic risk,” Bonnyham said.