Among thematic funds, dividend yield schemes have rewarded investors with a return of 24.26% over three years ending August 27, 2024, according to Value Research. Even as markets continue to rally, the BoB BNP Paribas NFO dividend yield fund opened for subscription on August 22.
“Globally, we are at a transition point from higher to lower interest rates. This is likely to lead to a shift in asset classes and geographies, leading to volatility. This could be the right time to consider dividend yield funds that invest in relatively stable companies and are likely to have lower volatility compared to the broader market,” says Shiv Chanani, Senior Equity Fund Manager, Baroda BNP Paribas Mutual Fund.
As of July 31, 2024, mutual funds managed AUM of Rs 30,638 crore across nine dividend yielding schemes, according to data from the Association of Mutual Funds of India (Amfi).
What do these funds do?
Dividend yield schemes invest in stocks that offer an attractive dividend yield. The dividend yield of a stock is calculated by dividing the dividend per share by the share price. For example, a stock trading at Rs 1,000 pays a dividend of Rs 30, then the dividend yield works out to be 3 per cent. The higher the dividend yield, the better it is as it tends to contain falls.
“Companies that pay high dividends are usually well-established and financially stable, which can make these funds less volatile compared to growth-oriented funds. For those looking for regular income, these funds provide a steady stream of income through dividends,” says Sailesh Jain, fund manager, Tata Mutual Fund.
Is this a sound criterion?
Companies that pay high dividends tend to have strong balance sheets. “Companies that pay high dividends tend to have strong cash flows and tend to be more stable,” says Atul Shinghal, founder and CEO of Scripbox.
However, dividend yield should not be considered in isolation. Investors should evaluate the consistency of dividend payments. Exceptional items that lead to higher dividend payments should be excluded. For example, a company that announces a special dividend to share the proceeds from an asset sale should not be confused with a high dividend yield stock.
You may miss opportunities
Dividend funds do not allow you to profit from companies that do not pay dividends or pay very low dividends but have high growth potential, such as companies in their early life stages. Many good companies, with high investment needs, usually want to preserve capital and rarely pay dividends. “Due to their focus on high-dividend paying companies, dividend funds usually avoid high-growth stocks. As a result, these funds may underperform compared to other equity funds when the growth investment style is favourable,” says Shinghal.
“In tough economic times, companies may reduce or eliminate dividends, which can negatively impact the fund’s performance,” Jain said.
What should you do?
Investing in dividend yield schemes can be a good option for investors with a relatively lower risk appetite. “These funds are suitable for investors looking for high-quality companies and are good for investors who predominantly invest in higher risk category funds,” says Chanani.
One should invest with a minimum five-year horizon using a systematic investment plan (SIP). “Generally, an investor can consider having 20-25% of their total exposure in mutual funds,” says Jain.
“For conservative investors or those approaching retirement, a higher allocation may be appropriate. Younger investors or those with a higher risk tolerance might consider a lower allocation, using dividend yield funds as a complement to more growth-oriented investments,” says Shinghal.
First published: August 29, 2024 | 19:28 IS
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