This is not a story about Pacific Gas and Electric Corp. (NYSE: PCG) upcoming bankruptcy filing. In the coming months and years you will see many!
This is a story about risk.
To put this in the context of today’s news, shares of PCG were cut in half at the open of Monday’s trading (1/14/19), after the gas and electric utility announced its plans to file for bankruptcy at the end of January. The reason? It faces enormous liability for its apparent negligence, lack of regulatory oversight and compliance, and inept inspections and maintenance of faulty equipment, resulting in the 2017 and 2018 Northern California wildfires that caused multiple deaths, personal injury and billions of dollars of damage. Criminal charges are expected.
For more details, just Google “PCG bankruptcy.” And While you’re there, Google “XLU.”
*XLU is a utilities sector ETF from the State Street Global Advisors’ SPDR lineup.
https://us.spdrs.com/en/etf/utilities-select-sector-spdr-fund-XLU
At this moment, the DJIA is down about one half percent, PCG is down a little over $8 a share, about a 48% decline, but XLU is down about 99 cents, about a 1.75% decline. It’s important to note that PCG is one of XLU’s thirty-plus utility company holdings.
And that’s why this is a story about risk. More to the point, ways to manage risk in your portfolio.
This difference in PCGs and XLUs performance in today’s market highlights one of the general and most appealing attributes of exchange traded funds, namely their ability to mitigate equity risk, that is, risk that is present in a specific company that can move the shares down.
From the SPDR website:
The Utilities Select Sector SPDR® Fund seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Utilities Select Sector Index
The Index seeks to provide an effective representation of the Utilities sector of the S&P 500 Index Seeks to provide precise exposure to companies from the electric utility, gas utility, multi-utility, and independent power producer and energy trader industries
The Utilities Select Sector Index seeks to provide an effective representation of the utilities sector of the S&P 500 Index. The Index includes companies from the following industries: electric utilities; water utilities; multi-utilities; independent power producers and energy traders; and gas utilities.
To be clear XLU, has its own inherent risks as a utilities sector investment proxy. For instance, all utility companies are affected by supply and demand, operating costs, government regulation, environmental factors, liabilities for environmental damage and general civil liabilities, and rate caps or rate changes. But having over thirty utility companies in a single portfolio gives inherent strength to your decision to invest in utilities.
Think of PCG as a single pencil that can be easily broken by anyone with even below average strength.
Now, think of XLU, or any ETF, as a whole bunch of pencils…thirty, fifty, or more than a hundred strong. Even Hercules would have his work cut out for himself snapping that handful in half.
Any ETF will present its own inherent risk characteristics, concentration risk being the most prevalent in any industry-specific ETF (utilities, finance, technology, and so forth) so just buying an ETF is not the entire solution to mitigating risk.
Risk management is about achieving true diversification across asset classes, sub classes, sectors, industries and companies, in the context of an objectives-based financial plan, centered around a passively managed portfolio of properly allocated, and located, assets. That’s where you want to be.
Once again, this story is about recognizing that risk comes in many forms, some of which, like equity risk, can be mitigated, not eliminated, by diversification. We can never fully eliminate risk in our portfolio’s, but we can take steps toward managing and reducing the various forms of risk so that we may stay invested and achieve positive returns over the long haul.
*WealthKeep is not affiliated in anyway with State Street Global Advisors and this article is not making a recommendation to buy or sell any specific security.