Slow and steady

FUND TREND

Dividend yield funds have underperformed diversified equity funds in the past year but there is still merit in holding on to them.

When the stock market is hovering close to its all-time high backed by hefty returns, it is hard to reconcile to a situation that your stock or fund gave only single digit returns.

So, for those who invested in dividend yield funds, the fact that every such scheme has ended up at the bottom of the performance chart may have come as a nasty surprise.

Nevertheless, there is really no reason to be disenchanted. The reasons for holding on to such funds now are just the same for which you bought these to begin with "" they are safer when markets are weak and provide better returns than fixed income securities.

Modest returns
Over the past one year, all the dividend yield funds have underperformed the equity indices.

While the broad category of diversified equity funds gave a return of 25.21 per cent, the four dividend yield funds whose one year returns are available posted an average return of 12.18 per cent.

But, most market experts are of the view that one should not compare the performance of dividend yield funds with the usual equity benchmarks.

As Shyam Sunder Bhatt, fund manager, Principal PNB Mutual Fund says, "There is no appropriate benchmark for these funds as the benchmarks available currently are mostly dominated by growth stocks and a dividend yield fund portfolio predominantly consist of value-oriented stocks."

He further adds, "We cannot even compare a dividend yield fund return with diversified equity fund category returns because they too are dominated by growth stocks."

Though dividend yield funds hold a diversified portfolio, they invest only in stocks that offer attractive dividends in their pursuit to keep risks low.

Less risky
Since companies pay dividends out of their earnings, dividend-paying companies are considered relatively stable and hence less risky than others that plough back larger proportion of their profits to fund further growth.

If the dividend that you earn per unit of share held as a proportion of your purchase price, called dividend yield, is high, the stock is perceived to be less risky. This is because as an investor you depend that much less on the stock market for rewards.

That explains why investing in stocks with high dividend yields is traditionally considered a defensive investment strategy. While historically, share prices of companies having high dividend yield have been less volatile than growth stocks, companies having a track record of dividend payment are also perceived to be shareholder-friendly.

Some of the common stocks seen in the dividend yield portfolios are ONGC (dividend yield: 4.53 per cent), Tata Chemicals (4.29), Hero Honda (3.65) and Great Eastern Shipping Company (5.85) as of March 2005.

Birla Sun Life Mutual Fund launched the first dividend yield fund, Birla Dividend Yield Plus in February 2003. Over the past one year, this fund managed to deliver only 7.02 per cent return as compared to the benchmark, S&P CNX 500 which returned about 23.5 per cent.

After Birla, five other fund houses""Principal PNB, Tata, UTI, ABN Amro and ING Vysya""launched dividend yield funds. If we compare the absolute returns of these funds over the past one year, Birla Dividend Yield Plus delivered the lowest returns of about 7.02 per cent.

UTI Dividend Yield Fund topped the category with about 20.5 per cent return and the second best in the category was Tata Dividend Yield Fund with returns of about 12.6 per cent.

Explaining the reason for the underperformance of dividend yield funds, Ved Prakash Chaturvedi, managing director, Tata Mutual Fund says, "A dividend yield fund's portfolio is dominated by mid cap stocks. Over the past six months, mid caps segment itself has underperformed due to poor liquidity in the market."

Also, Chaturvedi is of the view that one year is a short period for analysing the performance of such funds. According to him, one should wait for one market cycle to pass before assessing the performance of such funds.

For the bear hug...
Bhatt offers further perspective. "Investors prefer growth stocks to value stocks in a bull market," he says. So, during the bull run over the past one-and-a-half years, value stocks that form the core portfolio of dividend yield funds were ignored. As a result, these funds underperformed.

Fund managers are of the view that different funds perform well in different times. Some perform well in a bull market while others in bear markets.

And dividend yield funds perform better in volatile markets. Prateek Agrawal, head of equities, ABN Amro Mutual Fund says, "Every strategy works in a particular time frame. In a market which is not trending upwards focussing on dividend yields is a better strategy since it provides investors cushion when the market falls."

Swati Kulkarni, fund manager, UTI Mutual Fund also agrees that dividend yield funds perform better in volatile markets. She says, "These funds perform better than most other diversified equity funds when market are volatile thanks to their conservative approach."

The markets have been volatile over the past three months and during this period these funds have delivered returns close to their benchmarks. 
 

YIELDS AREN'T HIGH ENOUGH Scheme Performance (%) as on August 07, 2006
	3 months	6 months	1 Year
ABN AMRO Dividend Yield Fund - Growth	-27.50	-20.50	N.A.
Tata Dividend Yield Fund - Growth	-18.30	-6.20	12.60
Sensex	-12.50	7.20	39.40
Birla Dividend Yield Plus - Growth	-20.40	-11.30	7.02
PRINCIPAL Dividend Yield Fund - Growth	-19.90	-10.08	8.60
S&P CNX 500	-18.03	-1.10	23.50
ING Vysya Dividend Yield Fund - Growth	-23.10	-10.90	N.A.
UTI Dividend Yield Fund - Growth	-15.40	-4.40	20.50
BSE 100	-15.20	2.95	31.10

...and diversification
Bhatt is of the view that dividend yield funds are a good way to seek diversification.

Along with investing in diversified equity funds, which predominantly invest in growth stocks, the investor can also try these funds to have a blend of both value and growth stocks which could beat the markets at all times.

According to Paras Adenwala, chief investment officer, ING Vysya Mutual Fund, this is the best time to invest in dividend yield funds as these funds usually outperform when market falls. When markets are volatile, investors do not get the benefit of capital appreciation in stocks. But in the case of dividend yield fund, this loss is compensated by the dividend pay-out.

Adenwala says, "The potential for dividend yield funds continues to be attractive as by definition they are considered to be undervalued despite having reasonable growth and cash surplus."

In the long run, however, these may not be the best way to get exposure to equities. Says Kulkarni, "In a secular bull run, the funds that follow this approach may lag a bit in absolute returns, mainly on account of their restricted investment universe."

The key take away "" dividend yield funds are ideal candidates to invest in when the market is not going berserk. They are relatively safe bets when stocks are trending sideways or downwards.

These funds are a better alternative to fixed-income funds rather than pure equity funds that offer better wealth building potential.