The AI Boom Could Be a Bad Reason to Buy Utility Stocks. Try This ETF Instead.

The artificial intelligence (AI) stock boom has brought some surprising benefits to other parts of the economy, not just tech names. Energy stocks have gained from AI demand for electricity. Some construction companies and industrial stocks have also become AI-related stocks because they build data centers. Utility stocks have been another possible play for bullish AI investors.

Exchange-traded funds (ETFs) like the Vanguard Utilities ETF (NYSEMKT: VPU) make it possible to own a targeted portfolio of utility stocks at a low cost. This Vanguard ETF holds 68 utility company stocks and has delivered annualized returns of 14.4% for the past three years. Unfortunately, this fund has strongly underperformed the S&P 500 index and the tech-heavy Nasdaq-100 index year to date and over the past 10 years:

VPU Total Return Level data by YCharts

Are utility stocks really a good way to invest if you're optimistic about the AI boom? Based on recent trends and economic fundamentals, it seems unlikely that utility stock ETFs will be among the biggest beneficiaries of the AI boom. A better choice for AI optimists could be the Invesco QQQ Trust ETF (NASDAQ: QQQ). This tech ETF tracks the Nasdaq-100 and holds most of the world's major AI stocks.

Let's look at these two ETFs and see which could be a better choice for AI stock investors -- or for people who want more diversification from individual stocks.

Image source: Getty Images.

Vanguard Utilities ETF: 22 years of 9.8% annualized returns

The Vanguard Utilities ETF offers a focused portfolio of 68 stocks in utility companies (electric, gas, and water) and independent power generators. The fund was established in January 2004, and for the past 22 years, it has delivered average annual returns of 9.8%. This ETF charges a low expense ratio of 0.09%. It has a trailing 12-month dividend yield of 2.64%, which is competitive with the best dividend index funds.

The fund's top five holdings are: NextEra Energy (11.8% of the fund), Southern Company (6.7%), Duke Energy (6.2%), Constellation Energy (5.75%), and American Electric Power Co. (4.5%). Some investors have considered buying utility stocks as another way to gain exposure to the AI trade. The idea is that utility companies would benefit from rising electricity demand and selling power to AI data centers.

Unfortunately, the Vanguard Utilities ETF has underperformed the S&P 500 year to date, as well as the tech-heavy QQQ ETF. The AI boom doesn't seem to be leading to higher returns for utility stocks. Why? Utilities are very different from AI stocks.

Unlike asset-light, high-profit margin tech companies, utilities are highly regulated and asset-heavy. It takes a lot of expensive equipment and capital-intensive infrastructure to run a utility. Utilities also face the risk of backlash from local communities resisting the construction of data centers and the higher electricity prices that come with them.

If the AI boom delivers the hoped-for gains in productivity (and corporate profits), the biggest shareholder returns might not go to utilities but to AI stocks. And one of the best ways to buy AI stocks is to buy QQQ.

Invesco QQQ Trust ETF: 27 years of 11% annualized returns

The Invesco QQQ Trust ETF is one of the most prominent, popular, and profitable ways to invest in tech stocks. This tech ETF tracks the returns of the entire tech-heavy Nasdaq-100 index. Since the fund's inception in March 1999, "the Qs" has delivered average annual returns of 11%. And it charges a reasonably low expense ratio of 0.18%.

The QQQ fund's top five holdings are major tech names that are leading the AI boom:

• Nvidia: 8.1% of the fund
• Apple: 6.9%
• Alphabet: 6.57% combining Class A and Class C shares
• Micron Technology: 5.6%
• Microsoft: 4.47%

The top 10 holdings in QQQ include semiconductor stocks and AI hyperscalers benefiting from investor enthusiasm for new AI technologies. If the AI trade continues to build momentum and delivering strong returns for years to come, it seems most likely that those gains will go to companies in the Invesco QQQ ETF -- not utilities.

Why buy VPU or QQQ?

If you want to bet on the AI boom, you're probably better off buying QQQ. The tech ETF holds the major AI names that are likely to gain the most from a continued run-up in AI stock prices. But if you're worried about an AI bubble, and you want a defensive play that could protect your money in case of a 2022-style tech downturn, the Vanguard Utilities ETF might be a good choice.

Here's the best reason to buy the Vanguard Utilities ETF instead of QQQ: The utilities ETF performed much better in 2022 during the latest big downturn in tech stocks.

VPU Total Return Level data by YCharts

The Vanguard Utilities ETF gained 1.04% in 2022, while the S&P 500 lost 18.11%, and the QQQ fund lost 32.58%. Utilities might not gain as much from the AI boom, but they could be a safer place to invest in case of an AI stock bust.

Ben Gran has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Apple, Constellation Energy, Micron Technology, Microsoft, NextEra Energy, and Nvidia. The Motley Fool recommends Duke Energy. The Motley Fool has a disclosure policy.