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I want to buy an exchange-traded fund that invests in utilities. I am trying to decide between XUT and ZUT. What are your thoughts?

Utilities and power producers are a good choice for investors seeking income and modest capital growth. These companies supply products that are always in demand – namely electricity and natural gas. They pay solid dividends that in many cases grow every year. And they are on the conservative end of the investing spectrum because their returns are regulated or governed by long-term sales contracts. The advantage of owning an ETF over individual utilities and power stocks is that you get broad exposure to the sector, which increases diversification and reduces risk.

The iShares S&P/TSX Capped Utilities Index ETF (XUT) and the BMO Equal Weight Utilities Index ETF (ZUT) are similar in several respects. Both hold a basket of utilities and power producers, including familiar names such as Fortis Inc. (FTS), Emera Inc. (EMA), Algonquin Power & Utilities Corp. (AQN) and Brookfield Renewable Partners LP (BEP.UN).

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XUT and ZUT also have similar dividend yields and costs. XUT yields about 4 per cent, slightly higher than ZUT’s payout of 3.6 per cent. XUT’s management expense ratio is 0.62 per cent, virtually identical to ZUT’s MER of 0.61 per cent. Both ETFs pay dividends monthly.

The big difference is how the ETFs weight their constituents. Because XUT is weighted by market capitalization, its largest utility – Fortis – accounts for nearly 21 per cent of the ETF’s total assets. XUT’s next four constituents – Brookfield Infrastructure Partners LP (BIP.UN), Emera, Algonquin and Brookfield Renewable – collectively make up another 43 per cent. So just five of XUT’s stocks – out of 16 in total – account for 64 per cent of the fund.

Such heavy concentration is not ideal, because smaller renewable power companies – many of which have been on a tear this year as investors snap up green energy stocks – are significantly underweighted in XUT. Boralex Inc. (BLX) and Innergex Renewable Energy Inc. (INE), for instance, together account for just 5.2 per cent of XUT’s assets.

ZUT doesn’t have this problem because it gives each of its 14 constituents a roughly equal weighting. As a result, ZUT’s exposure to pure-play renewable electricity producers, at 30 per cent, is more than twice as high as XUT’s, at 14.3 per cent. ZUT’s higher weighting in the sizzling renewables sector is likely a major reason its total return of 22.3 per cent for the year ended Sept. 30 was more than twice as high as XUT’s total return of 10.7 per cent over the same period.

Will ZUT’s outperformance continue? That remains to be seen, but green energy is benefiting from a very strong tailwind as governments and corporations aim to reduce their carbon footprints. ZUT not only provides more exposure to the fast-growing renewables sector, but also provides better diversification overall thanks to its equal-weighting methodology. For these reasons, if I had to choose between the two, I would pick ZUT.

In response to your column last week about Fortis Inc. (FTS), when you write about a company could you also mention if it has a dividend reinvestment plan and how the DRIP would have affected the stock’s long-term return?

You can confirm whether a company offers a DRIP by visiting the investor relations section of its website or contacting the company directly. A Google search will often get you an answer even quicker. Fortis does have a DRIP and, effective Dec. 1, common shares purchased under the DRIP will be issued at a 2-per-cent discount.

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In last week’s column, I reported that Fortis’s annualized total return for the 10 years to Sept. 30 was 9.4 per cent. Total return figures include share price gains and dividends, which are assumed to have been reinvested in additional shares. Fortis' total return is therefore a close approximation of how an investor in the DRIP would have fared over that period. The total return, however, does not account for any DRIP discounts that may have been in effect, which could improve one’s returns. (Note: I use the “compound returns calculator” at canadastockchannel.com. It is an excellent – and free – tool for calculating total returns for Canadian stocks.)

Special to The Globe and Mail

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails, but I choose certain questions to answer in my column.

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