Amid the ongoing uncertainty of tariffs and geopolitics, one area of the corporate bond market that stands out as providing a stable and reliable source of income is the US electric utility sector.
The sector provides reliable, stable income due to regulatory frameworks that align revenues and expenses. This helps make utilities resilient across market cycles and enables them to pass many costs directly to consumers.
Utility debt is a complex asset class with issuance fragmented across multiple entities and this can often mean the sector prices at a discount to other comparable credits. A standout feature is the issuance of secured bonds with strong asset coverage and meaningful financial covenants.
Despite such credit quality, however, secured utility bonds offer wider spreads than lower-rated corporate bonds, enabling investors to enhance portfolio quality while picking up additional yield.
Wildfires remain a key headline risk for the sector but 2019 legislation, which created the wildfire fund (and, importantly, introduced a liability cap), significantly mitigates this. Our proprietary analysis suggests the market continues to overcompensate for wildfire risk.
At CG, portfolio positioning within the electric utility sector can broadly be split into two categories.
The first group are what could be termed sleep-at-night credits, which are mainly in America’s South-East and Midwest. These are solid, dependable issuers that provide a stable source of income, but due to the fragmentation described above, often trade with higher spreads than the broader corporate bond market.
The second group is the West Coast utilities. Much of the market takes a seasonal approach to investing in this sector, buying in winter before selling ahead of the summer “wildfire season”. The trouble with this approach is that wildfires are not seasonal - this year’s southern California wildfires occurred in January, well outside of the time period the market considers to be wildfire season.
As long-term investors, we think a better approach is to accept there may be some short-term volatility but to focus on the long term. Over this time horizon, our expectation is that sizeable positions identified through in-depth proprietary analysis should benefit from the structural tightening of spreads.
