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(Bloomberg) — Utilities stocks have emerged as an unlikely favorite of investors in Asia, and bets are growing that their standout rally this year has further to go.

Powering the sector’s boom after two years of losses are supportive local policies and the frenzy surrounding artificial intelligence, which is causing a dramatic increase in electricity demand in many parts of the world. As concerns grow about a potential global economic slowdown and rising geopolitical tensions, utilities firms’ high dividend payouts and the defensive nature of their stocks are also being touted as tailwinds.

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Up nearly 14% since the year began, the MSCI Asia Pacific Utilities Index is on track for its strongest annual gain since 2006. It ranks second, behind tech, in the list of 11 sub-gauges under MSCI’s broader Asian benchmark.

“It’s important to take a step back and consider the broader – and transformational – drivers of secular growth in the sector,” said David Smith, senior investment director of Asian equities at abrdn. “In recent years, there’s been a recognition that electricity demand growth, coupled with the demands of the energy transition, will require substantial and far-reaching investments into energy grids and power generation, as well as the software that controls grids.”

Local factors such as a robust Indian economy and China’s environmental ambitions are also playing a role in utility stocks’ relative outperformance versus the broader Asian market, as against their peers in the US and Europe.

Aided by a growing population and an expansionary fiscal policy, India’s power producers have thrived as local electricity prices rose on the back of supply shortages. In Japan, the government’s plan to accelerate the restart of nuclear reactors has spurred a rally among power companies that had struggled for years after the Fukushima disaster in 2011.

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“Asian countries have better fiscal balances and the political will to spend while the US is in the election year and so spending on power, infrastructure is not high on their agenda,” said Britney Lam, head of equities-long/short at Magellan Investments Holding Ltd. “Cash flow, dividend yields is the flavor as we head into rate cuts.”

‘Very Exciting’

Among the heavyweights in MSCI’s Asian utilities sub-index, India’s NTPC Ltd., Power Grid Corp. of India Ltd. and Japan’s Kansai Electric Power Co. have each risen close to or over 30% this year. Top gainers including Malaysia’s YTL Corp., India’s Torrent Power Ltd. and China’s CGN Power Co. have all surged more than 50%.

India is “a very exciting place to be right now, when it comes to utilities and the broader grid capex thematic,” said Smith of abrdn. “There’s clear and visible investment into the grid, an ambitious goal of increasing renewables capacity to 500GW by 2030, regulatory and policy continuity, and some high quality, well-managed companies that are potentially well-placed to capitalize on this.”

In China, the popularity of utilities firms partly results from a weak economy and a struggling stock market that has prompted investors to flock to defensive stocks with higher dividends. Meantime, Beijing’s lofty climate goals and an ongoing power market reform also have brightened the sector’s outlook.

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These measures are “expected to rationalize the public utilities pricing mechanism, reshape the value of assets such as water, electricity, and garbage disposal, and stimulate the vitality of green consumption through further institutional reform and innovation,” Topsperity Securities Co. analysts including Guo Lei wrote in a note.

The utilities sub-gauge is the best performer under China’s CSI 300 Index, with a gain of about 27% so far this year. The broader benchmark is down 2.5%.

The global AI frenzy also has increased investor appetite for utilities stocks in South Korea and Malaysia given the perceived demand boost from data centers. Korea’s HD Hyundai Energy Solutions Co. has jumped 9% this year, while Malaysia’s YTL has surged 85%. Asia’s broader equity benchmark is up 7.8%.

To be sure, just as the brutal selloff in major AI stocks since late July showed, skepticism has surfaced about the potential hype and bubble surrounding the new technology.

“It’s very difficult to measure the AI demand for electricity as we have to know how many display cards and other equipment these companies would use,” said Kelvin Ng, an analyst at Bloomberg Intelligence. Ng also cautioned against “very modest” earnings growth for Asian utilities firms in the next three to five years, except for those in India.

For many market watchers though, uncertainties related to the global growth outlook, tensions in the Middle East and the US presidential election are reasons to expect that the defensive utilities sector will outperform as market volatility increases.

“When both China and US are seeing rate cut, then these high-yield utilities become more attractive on the dividend yield gap angle,” said Dennis Ip, an analyst at Daiwa Capital. “Hong Kong utilities and China hydro-power utilities become a safe haven.”

—With assistance from Chiranjivi Chakraborty.

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