Dividend yield funds – who should invest?

Dividend yield funds have once again gained attention among the investors with the launch of NFOs like ICICI Prudential Dividend yield fund. Readers want me to write review on this product and I respect their demand. But I believe rather than asking specifically on ICICI dividend yield fund which has no history yet, readers should learn more about dividend yield strategy, how dividend yield funds works, what the other options available in market are and who should really invest in such funds?

This post is all about dividend yield funds.

What are dividend yield funds?

As the name itself suggests dividend yield funds are those where fund managers designs the fund portfolio as per dividend yield strategy.

When you invest in equity shares, you actually buy a portion of ownership in that particular company. Whatever profits that company generates some percentage of profit they distribute as dividends and balance they reinvest back in the company for future projects and growth. You get your portion of dividends depending on the number of shares you own.

Your total earning in equity investments is the sum total of dividend received and capital gains booked. Where Dividend comes out of the profitability of company, capital gains is the factor of Market price. If company’s fundamentals are sound and future prospects are good, then it gets reflected in market price also, which leads to increase in valuation/capital gains.

Dividend yield is a ratio that comes out by dividing the dividend distributed by the market price of stock. Normally high dividend yielding companies generally have stable business models with consistent profitability track record. And Good profitability is the result of good and accountable management with a competitive product line. The share price of these companies also tends to be less volatile. So overall selecting stocks on the basis of dividend yield is a wise and safe approach.

Past performance of existing dividend yield funds

Dividend yield funds are not specific market cap biased. It all depends on investment strategy of the fund and structure the specific fund house want to offer to investors. So one should never generalize as to what market cap dividend yield fund generally invests in. Check out the funds individually and select which market cap they invest in and you want to have exposure into.

As per the strategy, dividend yield stocks and thus funds are assumed to be less volatile and more stable as compared to its peers in the same category. You should not expect these funds giving high return when markets are rising but you may expect these funds to fall less in falling market. It is also true that high dividend yield strategy restricts the choice and fund manager cannot select the otherwise high growth stock which can bring good returns to the portfolio.

To figure out if the strategy really results in less volatility, I have done a check on 2 popular dividend yield funds and each of which has different benchmark. The comparison is not between themselves as both follow different market caps, but between their respective sector and benchmark.

(Also Read : Best Mutual funds to invest in 2014)

Funds selected are:

• Birla dividend yield fund which infact is the pioneer in this category and was launched in 2003. It is mid and small cap oriented fund.
• UTI dividend yield fund which is under Large and Mid cap category.

The comparison is at 3 levels-

1. for last 5 years,
2. In falling market (between 01 Jan 2008 to 10 March 2009) and
3. in rising market ( 10 march 2009 to 31 march 2010)

Birla Dividend yield fund – Performance last 5 years

Birla Dividend yield fund  in falling market ( 1 Jan 2008- 10 Mar 2009)

Birla Dividend yield fund in Rising Market (10 Mar 2009 – 31 Mar 2010)

UTI Dividend yield fund – Performance last 5 years

UTI Dividend yield fund  in falling market ( 1 Jan 2008- 10 Mar 2009)

UTI Dividend yield fund in Rising Market (10 Mar 2009 – 31 Mar 2010)

Should you invest in Dividend yield funds?

Before getting on to this question I would like to reiterate the basics of selecting equity funds.  One should be having a long term horizon and clear cut goal in mind before investing in any equity oriented fund. Though dividend yield funds are less volatile but it does not mean it is not volatile at all. It may fall less in down market but will surely fall. And in rising market one should not curse the selection as this strategy will limit the fund managers stock selection potential and thus other actively managed fund may out perform these dividend yield funds.

The above chart clearly shows how active funds selected on the basis of strategy being followed by us have generated returns as compared to dividend yield funds.  So if your horizon is long and you have good risk tolerance level then it is possible to generate better returns than dividend yield funds. Diversified funds where the selection is not based on a particular strategy has potential to deliver much better returns. But if volatility bothers you and you can compromise returns for safety, then yes you may try dividend yield funds.

Have you ever invested in Dividend yield funds? Do share your views and experiences.