(Bloomberg) — Utilities stocks have unexpectedly emerged as investors’ darlings in Asia, with bets growing that their stellar run will continue this year.

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The sector’s recovery after two years of losses is being driven by supportive local policies and excitement around artificial intelligence, which is driving dramatic increases in electricity demand in many parts of the world. Amid growing concerns about a potential global economic slowdown and rising geopolitical tensions, utilities’ high dividend payouts and the defensive nature of their stocks are also being touted as tailwinds.

With a year-to-date increase of nearly 14 percent, the MSCI Asia Pacific Utilities Index is on track for its strongest annual gain since 2006. It ranks second behind the technology sector in the list of eleven sub-indices of the broader Asian MSCI benchmark.

“It is important to step back and look at the broader – and transformative – drivers of long-term growth in this sector,” said David Smith, senior investment director for Asian equities at abrdn. “Over the past few years, it has become clear that growth in electricity demand, coupled with the requirements of the energy transition, will require significant and far-reaching investment in energy networks and power generation, as well as in the software to control the networks.”

Local factors such as India’s robust economy and China’s environmental ambitions also play a role in the relative outperformance of utility stocks against the broader Asian market compared to their counterparts in the US and Europe.

India’s power producers have rallied thanks to a growing population and expansionary fiscal policy, while local electricity prices have risen due to supply shortages. In Japan, the government’s plan to speed up the restart of nuclear reactors has sparked a recovery in energy companies that have struggled for years since the Fukushima disaster in 2011.

“Asian countries have better fiscal balance sheets and the political will to spend money while the U.S. is going through an election, so spending on energy and infrastructure is not high on their agenda,” said Britney Lam, head of equity long/short at Magellan Investments Holding Ltd. “Cash flow and dividend yields are the most important thing as we move toward rate cuts.”

“Very exciting”

Heavyweights in the MSCI Asian utilities sub-index include India’s NTPC Ltd., Power Grid Corp. of India Ltd. and Japan’s Kansai Electric Power Co., each up nearly or more than 30 percent this year. Top gainers, including Malaysia’s YTL Corp., India’s Torrent Power Ltd. and China’s CGN Power Co., are all up more than 50 percent.

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India is “a very exciting place at the moment when it comes to utilities and the broader issue of grid investment,” said abrdn’s Smith. “There is clear and visible investment in the grid, an ambitious target to increase renewable energy capacity to 500GW by 2030, regulatory and policy continuity and some high-quality, well-run companies that are potentially well positioned to benefit.”

In China, the popularity of energy utilities is partly due to the weak economy and faltering stock market, which has prompted investors to invest in defensive stocks with higher dividends. At the same time, Beijing’s ambitious climate goals and an ongoing electricity market reform have also brightened the sector’s prospects.

These measures are intended to “rationalize the pricing mechanism of public utilities, redesign the value of goods such as water, electricity and garbage collection, and boost the vitality of green consumption through further institutional reforms and innovations,” analysts at Topsperity Securities Co., including Guo Lei, wrote in a note.

The utilities sector is the best performer in China’s CSI 300 index, gaining around 27 percent so far this year. The broader benchmark is down 2.5 percent.

The global hype around artificial intelligence has also boosted investor interest in utilities in South Korea and Malaysia as demand for data centers has increased there. Korea’s HD Hyundai Energy Solutions Co. share price has risen 9 percent this year, while Malaysia’s YTL has gained 85 percent. The broader Asian stock index has risen 7.8 percent.

What is certain is that, as the brutal sell-off in major AI stocks since late July has shown, skepticism has arisen about the possible hype and bubble surrounding the new technology.

“It’s very difficult to measure AI power demand because we need to know how many graphics cards and other devices these companies would use,” said Kelvin Ng, an analyst at Bloomberg Intelligence. Ng also warned of “very modest” earnings growth for Asian utilities over the next three to five years, excluding those in India.

However, given the uncertainties surrounding the global growth outlook, tensions in the Middle East and the US presidential election, many market observers expect the defensive utility sector to perform better as market volatility increases.

“When interest rates are cut in both China and the U.S., these high-yielding utilities will become more attractive from a dividend yield perspective,” said Dennis Ip, an analyst at Daiwa Capital. “Hong Kong utilities and Chinese hydropower companies will become safe havens.”

– With support from Chiranjivi Chakraborty.

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