What Is the Vanguard Utilities ETF, and Who Should Buy It?

Recent run-ups in tech stock valuations and all-time highs in the S&P 500 index have led some investors to worry that growth stocks are overpriced. Buying utility stocks and utility exchange-traded funds (ETFs) can be a good move for some situations and strategies -- like if you want to hedge against a possible tech downturn or future recession.

Utility stocks tend to earn steady income and pay above-average dividends. These companies have also benefited from rising demand for electricity related to the artificial intelligence (AI) data center build-out. But utilities have a few risks and downsides. They're not the right fit for every investor.

The Vanguard Utilities ETF (NYSEMKT: VPU) is a low-cost way to invest in dozens of utility companies that distribute electricity, gas, water, or operate as independent power producers. This fund has underperformed the S&P 500 for the past five years. But investors who want exposure to this specific area of the economy can use the Vanguard Utilities ETF to easily buy a portfolio of utility stocks at a low expense ratio of 0.09%.

Let's take a closer look at this Vanguard ETF and see if it might make sense for your portfolio.

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67 stocks, 22 years of 9.8% annualized returns

The Vanguard Utilities ETF holds a total of 67 stocks. This Vanguard ETF has delivered average annual returns (by net asset value) of 11.9% in the past year, 14.4% in the past three years, 9.6% in the past five years, and 9.4% in the past 10 years. Since the fund's inception in January 2004, it's delivered average annual returns of 9.8%.

Most of the fund's assets are in electric utilities (62.4% of the fund) and multi-utilities (24.2%) that provide more than one type of utility service. Gas utilities make up 4.9% of the fund, and independent power producers account for another 4.9%. The fund also holds shares in water utilities (2.8%) and renewable electricity companies (0.8%).

Those returns might look pretty steady, and the Vanguard Utilities ETF has paid a strong dividend yield of 2.52% in the past 12 months. But this fund has underperformed the S&P 500 for most of the past 10 years. If you'd invested $10,000 in the S&P 500 10 years ago, you'd have $42,850 today -- while that same $10,000 investment in the Vanguard Utilities ETF would have only grown to $23,740.

VPU Total Return Level data by YCharts

Why (or why not) to buy the Vanguard Utilities ETF

There's a lot of interest in utility stocks right now because of the AI boom. But investors should keep in mind that utilities aren't the same as AI stocks. Utilities are asset-heavy, heavily regulated, and expensive to operate.

Utility companies might grow along with the build-out of AI infrastructure, but their profit margins are unlikely to be anywhere near as large as the fastest-growing AI stocks and major tech names. There are liabilities for utility investors as well as upside.

Perhaps the best reason to buy utility stocks is to protect against a tech downturn. The Vanguard Utilities ETF has sometimes outperformed the S&P 500 index and even the tech-heavy Nasdaq-100 index. For example, during the latest bear market in tech stocks during 2022, the Vanguard Utilities ETF outperformed both of those benchmarks:

VPU Total Return Level data by YCharts

However, the long-term upside of utility stocks feels limited. I prefer to diversify my portfolio beyond just 67 stocks in a heavily regulated industry. There are other ways to make defensive moves and earn high dividend yields. I don't own this ETF, and I wouldn't recommend it for most investors.

Ben Gran has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.