As the name suggests, Dividend Yield Funds invest in stocks that reward shareholders with consistent and high dividend payouts, bonus shares or share buy backs. They invest a minimum of 65% in equities.
These funds are benchmarked against the Nifty Dividend Opportunities 50 Index that tracks companies with high yield. Though they can invest across market capitalisation and sectors, these funds tend to have large cap bias. Most of these funds have invested at least 50% of net assets in large cap firms. Dividend Yield Funds typically invest in mature, healthy cash flow, less volatile and capital-intensive businesses like utilities, mining, etc.
“When choosing stocks in the portfolio, fund managers tend to look at the Nifty Dividend Opportunities 50 Index. But dividend payout history is just the initial mathematical screen. They look at the stock’s that are available at a fair price with robust balance sheets, return on equity/return on capital employed, and so on. They rely on relative valuation techniques (peer group and historical valuation) when evaluating companies,” says Nehal Meshram, Senior Analyst, Morningstar Investment Advisers India.
They tend to be relatively less risky than other types of funds such as mid or small cap funds or growth style-oriented funds. Of the seven funds, four funds have a blend style (mix of growth and value), two funds have a value tilt while one fund is growth oriented. The style indicates the mix of stocks in the underlying portfolio of schemes.
Dividend yield stocks become attractive when real interest rates decline, liquidity rises and companies are reluctant to invest in capex and thus tend to pay out dividends or buy back shares.
There are only seven Dividend Yield Funds in the industry that collectively manage assets worth Rs 6,735 crore, indicating that the category has not taken off in a big way.
Performance of Dividend Yield Funds
NIFTY Dividend Opportunities 50 Index
The companies that form part of the index are from within the top 300 companies by average free float market capitalisation and average daily turnover for the last six months.
A dividend yield of each company is calculated using total dividend amount in the last 12 months (calculated based on ex-dividend date) prior to the rebalancing reference date using average market capitalization for one year period ending January. The top 25 companies ranked by annual dividend yield are included in the index and companies ranked below 75 by annual dividend yield are excluded from the index.
The top five sectors constituting the index weightage are consumer goods (28.05%), IT (25.64%), construction (9.74%), Oil & Gas (8.05%) and power (7.64%). Companies with the highest weightage in this index are HUL (10.46%), TCS (9.98%), ITC (9.94%), Infosys (9.87%), and L&T (9.74%). Each constituent is capped at 10%.
NIFTY Dividend Opportunities 50 Index has delivered 11.45% CAGR since inception (2007). Over a five-year period as on March 31, 201, it has delivered 14.20% CAGR.
The index has Price to Earnings Per Share Ratio or P/E of 21.13 and Dividend yield of 3.05%. The P/E of this index is lower than other indices such as Mid Cap (40.58) and Nifty Small Cap (64.36).
The tax advantage
Dividend received from investee companies is tax free for mutual funds. Fund houses receive income without any deduction of tax at source under the provisions of Section 196(iv) of the Income Tax Act.
With effect from April 1, 2020, the dividend is taxed only in the hands of investors.
Mutual funds deduct 10% and 20% Tax Deduction at Source (TDS) on dividend income paid to resident unitholders and Non-Resident Individuals, respectively. This is applicable if the dividend income is above Rs 5,000. Thus, it is advisable for investors to opt for growth plans.
If you are looking for income from dividend, should you choose the mutual fund route or direct equity route? “Dividend Yield Fund will follow a mandate and actively manage the portfolio. The same is not easy to do using the direct equity route. In a diversified portfolio, Dividend Yield Fund can be a small allocation. The dividend gains get converted into capital gains at 10% above one year versus marginal tax rate which is 30% plus,” says Vinod Jain of Jain Investment.
In the recent past, only one fund house – Tata Mutual Fund has filed for launching a similar scheme. Not many fund houses are keen to launch Dividend Yield Funds. Even the existing schemes have not garnered enough assets. The largest scheme UTI Dividend Yield manages assets worth Rs 2,618 crore.
You can allocate some portion to such funds if you are looking for dividend income but do note that even other diversified fund categories can take exposure to dividend-yielding firms.
Financial advisers say that such funds cannot be a core part of the portfolio. "I feel diversified equity funds are better as the scope of diversification is limited in Dividend Yield Funds,” says Mumbai-based Registered Investment Adviser Melvin Joseph.
