Yielding to dividends

Dividend yield funds are good to hedge risk, as they perform better during bearish phases.

Are you an investor who loves to invest in high dividend yielding stocks? Well, then there are mutual funds in the market as well that cater to your needs. However, before you go ahead and invest in such funds, it is important that you go through the documentation carefully to know the mandate of these funds. This will help you to decide the ones that suit your needs.

But before that what is dividend yield? It is defined as the financial ratio that shows how much a company pays out in dividends each year as against its share price (Dividend payout/Share price). In the absence of any capital gains, the dividend yield is the return on investment for a stock. For instance, if the price of scrip A is Rs 100 and scrip B is 50 and both declare dividends of Rs 5 per share, then in case of B the per cent of returns is higher at 10 per cent (for scrip A it is 5 per cent). At present, there are currently seven dividend yield funds. These are from ABN AMRO, Birla, Escorts, ING, Principal, Tata Mutual Fund and UTI.

While all of them have mandates to invest in high yield stocks, the specific mandates of a few of them are outlined below:

ABN Amro defines high dividend yield stocks as stocks of those companies having a yield in excess of 0.50 per cent.

Tata Mutual states that dividend yield will be considered high, if it is greater than that of the last released data of the BSE Sensex.

Principal invests predominantly (at least 65 per cent of the net assets) in companies that have a relatively high dividend yield, at the time of making the investment. The fund defines dividend yield as 'high', if it is in excess of 1.5 times of the prevailing dividend yield of the Nifty.

The other schemes do not clearly state that their portfolio will include high dividend yield stocks which could provide substantial capital protection and a strong possibility of capital gains. If one looks at the portfolio composition, most of them have energy and financial stocks as the top holdings.

Performance
Such funds generally perform better during bearish phases as stock prices are lower and dividend yields are high. In a sense, these funds are similar to contra funds which buy value stocks at reasonable prices and sell them when the value-based reasoning no longer holds true.

However, for the past four years stocks are generally moving upwards and therefore dividend yields are falling. Hence, these funds have displayed a mixed performance as against the Nifty in the last one year. (See: Returns from dividend yield funds)

The fact that these funds are not really favourites is evident from the fact that the total assets under management (AUM) for this category is under Rs 1,500 crore, with UTI Dividend Yield Fund being the largest with a corpus of around Rs 850 crore. When should you invest?
1.These funds can be looked at, after you already have a good portfolio of diversified funds. As it is always said, it is important that you do not have all your eggs in the same basket. Similarly, over exposure in these funds can hurt you because of excessive concentration in stocks, which are less loved by the market. They are the exact opposite of aggressive funds or sector funds, which people buy for great returns in a bullish market.

2.In case you have decided to go in for one such fund, choose the one which has been true to its mandate. For instance,

ABN AMRO has changed its mandate recently to include stocks which are having a yield of just 0.50 percent. This negates the concept of a dividend yield fund, as virtually every dividend paying stock can now be included in this fund. Hence, one might as well invest in any diversified equity fund.

3.Do not buy these funds merely because you have a bearish view on the market in the immediate future. The net asset value (NAV) of these funds will also fall in line with the market in the initial stages of a falling market. Get into these funds only once you believe that the market is in its secondary stage of a bear market where the risk-reward ratio is favourable.

In other words, like a contra fund, dividend funds are good portfolio diversifier and provide stability to your portfolio.

(The writer is a certified financial planner.)