Dividend Yield Funds

When it comes to investments, you often need to choose between growth and stability. Some funds offer growth but lack stability, while others provide stability but not necessarily the returns you expect. Dividend-yield funds are mutual funds that try to balance growth and stability by investing in stocks that pay regular dividends and have growth potential.

In this comprehensive section, we will explore the concept of dividend yield funds, their advantages and disadvantages, and why they are becoming increasingly popular in India.

According to SEBI, dividend-yield funds are equity-oriented mutual funds that invest at least 65% of their total assets in dividend-paying stocks. A dividend is a distribution of a part of a company's earnings to its shareholders. When a company generates profits, it may choose to distribute a portion of those profits to its shareholders as dividends.

Dividend yield funds focus on investing in companies with a consistent record of paying dividends. These funds aim to generate income for investors by investing in dividend-paying stocks. The dividend yield is calculated by dividing the annual dividend per share by the stock's price.

Example: Suppose a company pays an annual dividend of ₹10 per share, and its stock trades at ₹200 per share. The dividend yield would be calculated as follows:

Dividend Yield = (₹10 / ₹200) * 100 = 5%

In this case, the dividend yield for this particular stock is 5%, meaning that for every ₹200 invested in the stock, an investor will receive ₹10 as an annual dividend.

1. Regular Income Stream: The primary advantage is the potential for regular income through dividend payouts, creating a reliable source of cash flow. This is especially attractive for retirees or investors seeking to supplement their income.
2. Potential for Stability: Dividend yield funds often invest in well-established companies with stable earnings and a track record of dividend payments. These funds may exhibit lower volatility compared to pure growth-oriented funds, particularly during market downturns.
3. Compounding Potential: Many dividend yield funds offer a dividend reinvestment option, allowing you to purchase additional shares with the dividends received. This compounding effect can lead to significant growth of your investment over the long term.
4. Portfolio Diversification: Dividend yield funds can add diversification to an Indian investor's portfolio that might be heavily focused on growth stocks. These funds might invest in mature companies across various sectors, broadening your investment exposure.

1. Limited Capital Appreciation Potential: While dividend yield funds offer income, their potential for significant capital appreciation might be lower compared to growth-oriented funds that invest in rapidly expanding companies. Investors prioritizing high capital growth may need to compromise on some growth in favour of income.
2. Market Risk and Volatility: Even companies with strong dividend histories are subject to market fluctuations that can impact their share prices, leading to potential capital losses. Dividends can be reduced or suspended entirely, especially if a company faces economic headwinds or changes its dividend policy.
3. Sector Concentration: Dividend yield funds in India might have a higher concentration in specific sectors traditionally known for paying dividends (e.g., utilities, consumer staples). This can lead to increased vulnerability if a particular sector faces challenges or underperforms.
4. Potential for Underperformance: In strong bull markets, growth-oriented funds might significantly outperform dividend yield funds. Dividend yield funds might miss out on the high-growth potential of newer, innovative companies.

As of May 2024, the AUM of dividend yield funds in India stood at INR 26,050 crore, indicating their growing popularity among Indian investors. Comparing the returns of the Nifty 50 and the Nifty Dividend Opportunities 50 from June 19, 2023, to June 19, 2024, shows that the Nifty 50 gave 25.40% returns, while the Nifty Dividend Opportunities gave 47.40%. Although one-year returns are not enough to make investment decisions, they highlight the potential of dividend yield funds.

• Long-Term Investors Seeking Stability: Ideal for those who are looking for steady income and growth over the long term.
• Risk-Averse or Conservative Investors: Suitable for investors who prefer stability and lower volatility.
• Investors Looking for Long-Term Wealth Preservation: Beneficial for those who want to preserve wealth with the added advantage of regular dividend income.

Dividend yield funds can offer better stability and protection during market downturns than other equity funds. Since these funds focus on companies that pay regular dividends, the dividends can provide an added cushion during market volatility. The lower volatility associated with dividend yield funds can offer peace of mind to investors prioritising capital preservation.

Amit Nadekar, Senior Equity Fund Manager at Canara Robeco Mutual Fund, noted that over a span of 10 years or more, dividends usually make up around 30-40% of the total returns from stocks, with the remaining 60-70% influenced by stock price increases. This underscores the value of dividends in an investor's portfolio. In conclusion, dividend yield funds are great for investors who prefer stability over high returns and want to invest for the long term.