Fans of utilities, stocks famed for their high dividends, defensive qualities and excellent long-term track record, include legendary investor Warren Buffett and British star manager Neil Woodford. Yet Labour leader Ed Miliband’s proposals to freeze energy prices, should he become prime minister, has created some skittishness towards the quoted utility sector, impacting sentiment towards British Gas owner Centrica (CNA), National Grid (NG.) and SSE (SSE).

Polls are underway (7 May) as Shares hits the shelves, but if it succeeds in the election, Labour aims to introduce a range of policies to make energy prices ‘fair’. They include a price freeze, a possible break-up of the industry into sub-components and scrapping energy regulator, OFGEM, in order to replace it with a regulator ‘with teeth’.

Bond proxies

Also weighing on sector sentiment in the UK and the US is the prospect of interest rate rises, causing a pullback in utility shares which are considered, rather lazily, to be ‘bond proxies’. The upshot of all this is that while utilities have a reputation for being boring, stable investments, presently, the sector is anything but risk-free.

Nevertheless, for those investors still eager to access the cash flows, dividend payments and high yields on offer from water and waste, electricity, gas and renewable energy providers, risk mitigation is offered by diversified collective funds with a broad spread of investments.

Generalist investment trusts hold quoted utilities, while in the Association of Investment Companies’ (AIC) specialist infrastructure sector, the likes of 3i Infrastructure (3IN) and others offer access to high-quality infrastructure investments with utility-like qualities - namely stable income, high yield and defensive characteristics.

The first port of call should be the pureplay trio making up the Specialist Sector: Utilities space. Each trust offers exposure to a diverse number of holdings and a broad sweep of assets diversified internationally. This might entreat investors worried by the prospect of UK energy price freezes to take a look. What’s more, all three trusts trade at a discount to net asset value (NAV), the size and scope of each reflecting perceived risks as well as the past performance of the trusts in question.

Investors should also note that the trio have classes of Zero Dividend Preference shares, known as ‘zeros’ or ‘ZDPs’. Standing ahead of the ordinary shares in the event something goes wrong, ZDPs aim to deliver a fixed amount of capital growth over a set period of time, akin to a debt instrument, but they don’t pay any income. From an investors’ point of view, the main benefit is the return you get from a ZDP is taxed as a capital gain rather than income, which means ZDPs are suitable for long-term saving in a tax-efficient way. From a trust’s point of view, ZDPs impose no cash drain on the fund, while also enabling the company to pay a higher dividend to its ordinary shareholders. Utility funds are thought to have stable portfolios and are therefore well-suited to carrying debt in the form of ZDP shares.

Discount trades

The aforementioned three include Utilico Investments (UTL), a £115 million cap which seeks to maximise returns by spotting investments where the underlying value is not reflected in the market price. A significant portion of the portfolio is invested in developed markets-based water and sewage companies, as well as waste, electricity, gas, telecommunications, ports, airports, rail and road assets.

Yet added diversification is on offer via exposure to the emerging markets utilities and infrastructure sectors through its holding in Utilico Emerging Markets (UEM). Other top 10 positions include airports-to-waste-energy investor Infratil (IFTX:NZ), electronic payment services play Touchcorp (TCH:ASX), listed on the Australian stock exchange earlier this year, as well as UK-listed waste treatment concern Augean (AUG:AIM).

Also trading at a wide discount, possibly reflecting its under-performance of the MSCI World Index on a five-year view, is Ecofin Water & Power Opportunities (ECWO), managed by specialist utility, alternative energy and infrastructure investor Ecofin. The trust’s objective is to achieve a high, secure dividend yield and drive long-term capital growth in portfolio assets, while taking care to preserve shareholders’ capital.

Diversification is certainly a plus point with this trust, invested in utilities involved in everything from the generation of electric power, to water treatment and distribution and those involved in treating waste, distributing natural gas and the transmission of energy. Invested in the likes of US-based oil and gas explorer Lonestar Resources (LNR:ASX), as well as E.ON and SSE, Ecofin’s geographical spread is reassuring, encompassing the US and Canada, Europe, the UK and the emerging markets.

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Premier power

Shares believes a very canny way to diversify portfolios and gain some global utility sector exposure is via Premier Energy & Water Trust (PEW), trading at a discount with scope to narrow and offering an attractive dividend yield.

With £77.8 million in gross assets at last count, the trust aims to deliver a high income and realise long-term growth in the portfolio’s capital value. The trust invests in companies operating in the energy and water sectors, as well as other infrastructure investments and can also invest up to 15% in other investment companies that themselves invest in utilities and infrastructure.

Furthermore, Premier Energy & Water invests in both developed and emerging markets, mindful of capitalising on the global opportunity set in the utility markets. This means the fund is highly-diversified. As at end-March, the UK spoke for only 15.8% of the geographical allocation. At this date, the portfolio’s geographical breakdown shows China as the most significant region at 21.8%. It is followed by Asia ex-China at 17.1%, the UK and then North and Latin America at 12.7% and 8.5% respectively.

As co-manager James Smith explains: ‘As a utility investor it is important to be geographically diverse and also able to switch between jurisdictions as political environments change. The sector is a series of largely non-correlated national markets, and it is entirely possible for the sector to have an excellent year in, say, Spain and a poor one in France, for example. It all depends on local regulatory and political conditions. With this in mind, we are cognisant of the potential ramifications of a change of Government in the May election. As such we are only slightly exposed to downstream UK retail energy supply and hold only one investment, SSE, with any activities in this area. In total, less than 0.5% of the portfolio is exposed to this politically-sensitive activity.’

The fund offers exposure to companies including Indian power plants play OPG Power Ventures (OPG:AIM) and wind farms operator Renewable Energy Generation (WIND:AIM), as well as to the theme of a cleaner Peoples’ Republic through China’s biggest privately-owned waste to energy plant operator China Everbright International.

Slower economic growth in China is likely to maintain downward pressure on coal prices, benefitting one of the country’s biggest power companies, portfolio holding Huaneng Power International (902:HK). Somewhat counter-intuitively, Smith believes any slowdown or rebalancing of the Chinese economy is in fact likely to have a positive impact for the power sector, since downward pressure on coal prices means improved margins for power generators.