What are dividend yield funds? Who should invest in them?

Unlike popular perception, dividend yield funds are not mutual funds that provide regular dividends. They are ones that invest in high yield stocks.

Kavya Balaji   /   December 18, 2020
dividend yield funds

Equity investments are known to give higher returns when compared to other asset classes such as fixed income. However, many investors forget the fact that apart from the capital gains from equity investments, these investments provide dividends as income. A lot of companies in India provide their shareholders with dividends from a part of their earnings. While paying dividends to investors is not mandatory, many companies do it to make the investment in the company stock more attractive.

There are investors who think that direct equity investments are too risky. Those investors who want to enjoy the benefits of dividends can consider investing in dividend yield funds. Here is the info on dividend yield fundsand how they work.

What is a dividend yield fund?

Dividend yield funds are not those that pay regular dividends. They aren’t mandated to pay dividends. Dividend yield funds use dividends as a strategy. They invest in stocks that come with high dividend yields.

To understand this, let’s understand dividend yield. The dividend yield is the ratio of a company’s dividends when compared to the company’s stock price. This is a ratio that considers all the past paid dividends and compares them to the market price of the shares. 

The comparison with the market price of the shares helps investors understand if the price of the shares is very high. So, dividend yield stocks are not just stocks that pay dividends, they are stocks that have value in them. The dividend yield helps choose stocks based on the dividends and price.

What are the features of a dividend yield fund?

A dividend yield fund invests most of its assets in stocks with high dividend yields. As per the guidelines by the Securities Exchange Board of India (SEBI), these schemes need to invest a minimum of 65% of their assets in dividend yielding stocks. So, the fund does not invest entirely in good dividend paying stocks. The fund manager can choose other stocks to invest the assets of the funds. When some of those stocks do not pay out dividends, the distributable surplus of the fund will be less. 

The most important point is that the way dividend stocks are chosen is different for various funds. For instance, some funds use the Nifty 50 as benchmark for choosing dividend yield funds. If the dividend yields of the stock chosen by the fund exceed that of the dividend yield of Nifty 50, then the fund will consider the stock a high dividend yield stock. There are other funds that use the Sensex or the Nifty Dividend Opportunities index as benchmarks. 

What are advantages of dividend yield funds?

Dividend yield funds can act as a hedge against market turmoil. How? This is because they invest in companies with a steady stream of revenues. If a company has reliably paid out healthy dividends over the years, this means it’s a stable company. Since these funds are always invest with such companies, they are considered safer for medium risk investors. 

Dividend yield funds usually provide significantly better yield on investments in a bull run as mostly good stocks are in the portfolio.

Who should invest in dividend yield funds?

Those who are looking to invest in equity funds can consider dividend yield funds. This should not be chosen by those who have a low risk profile because the returns of dividend yield funds may not be stable. The fund can be volatile between bull and bear cycles. 

Even those with an aggressive risk profile and looking for higher returns shouldn’t consider dividend yield funds as their long-term returns aren’t high. For instance, while Templeton India Equity Income Fund has provided investors with 16.9% in the past year, the 5-year return of the fund is just 9.27% which is much lower than that of other large cap funds such as Axis Bluechip Fund that has given 14%. Pure equity funds such as mid-cap and small-cap funds are a better choice for aggressive investors. Dividend yield funds can be used to diversify an investor’s portfolio. 

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