Is your portfolio heavy on growth strategy? Add dividend yield funds

"Companies that pay high dividends typically have strong cash flows and tend to be more stable," Atul Shinghal, Founder and CEO of Scripbox, says

Among thematic funds, dividend yield schemes have rewarded investors with 24.26 per cent returns over three years ended August 27, 2024, according to Value Research. Even as markets continue to rise, Baroda BNP Paribas Dividend Yield Fund NFO opened for subscription on August 22.

“Globally, we are at a point of transition from higher to lower interest rates. This is likely to lead to a shift across asset classes and geographies, leading to volatility. This could be the right time to consider dividend yield funds which invest in relatively stable companies and are likely to have lower volatility compared to the broader market,” says Shiv Chanani, Senior Fund Manager – Equity, Baroda BNP Paribas Mutual Fund.

 

As of July 31, 2024, mutual funds managed AUM of Rs 30,638 crore through nine dividend yield schemes, according to data from the Association of Mutual Funds in India (Amfi).

What do these funds do?

Dividend yield schemes invest in stocks that offer attractive dividend yield. The dividend yield of a stock is computed by dividing the dividend per share by the price of the stock. For example, a stock quoting at Rs 1,000 pays out 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 downside. 

“Companies that pay high dividends are often well-established and financially stable, which can make these funds less volatile compared to high growth-oriented funds. For those seeking regular income, these funds provide a steady stream of income through dividends,” says Sailesh Jain, Fund Manager, Tata Mutual Fund.

 Is it a sound yardstick?

Companies with high dividend yields generally have strong balance sheets. “Companies that pay high dividends typically have strong cash flows and tend to be more stable,” says Atul Shinghal, Founder and CEO of Scripbox.

However, dividend yield should not be seen in isolation. Investors should assess the consistency of the dividend payout. Exceptional items leading to higher dividend payouts need to be excluded. For example, a company announcing a special dividend to share the proceeds of a sale of assets should not be confused as a high dividend yield stock.

Can miss opportunities

Dividend yield funds do not let you gain from companies that do not pay dividends or pay very low dividends but have high growth possibilities, such as companies in their initial phase of life. Many good companies, with heavy investment needs, typically want to conserve capital and seldom pay dividends. “Due to their focus on high-dividend-paying companies, dividend yield funds often avoid high-growth stocks. As a result, these funds may underperform compared to other equity funds when the growth style of investing is in favour,” Shinghal says.

“In tough economic times, companies might reduce or eliminate dividends, which can negatively impact the fund’s returns,” says Jain.

What should you do?

Investing in dividend yield schemes may work for investors with relatively less risk appetite. “These funds are suitable for investors looking for high-quality companies and are good for investors who are predominantly invested in higher-risk category funds,” Chanani says.

One should invest with a minimum five-year view using a systematic investment plan (SIP). “In general, an investor may consider having 20-25% of their overall mutual fund exposure to these funds,” Jain says.

“For conservative investors or those nearing retirement, a higher allocation may be appropriate. Younger investors or those with higher risk tolerance might consider smaller allocation, using dividend yield funds as a complement to more growth-oriented investments,” Shinghal says.