Dividend yield mutual funds have delivered reduced returns, averaging 22% and disgustingly underperforming the 31% jump in the BSE Sensex over the past year. The returns over a two- and three year period are miserable, with yields averaging 47% and 119%, as against 86% and 175% posted by the BSE Sensex in the same period. Investors in dividend yield funds would have done improved to invest in an index fund or diversified equity fund.
Dividend yield funds invest in companies that pay elevated dividends. The dividend yield strategy works on the hypothesis that income received from dividends helps investors compulsorily book profits, and thus acts as a hedge during volatile market conditions. A dividend is cash paid from the income of a company, and dividend yield is the yearly dividend per unit of a stock divided by its market price. In new words, it is a way to measure the cash the investor gets back on each rupee invested in the stock.
Like any other approach, dividend yield investing has its pros and cons. Steady or progressively increasing dividends point out a company's ongoing success. Dividends cannot be manipulated, as they involve cash payment but we can manipulate earnings. A company paying fixed or high dividends is likely to be fundamentally well-built.
Critics of dividend yield investing argue that investors are not concerned with a company's dividend policy, as they can trade part of their holdings when they need cash, and as returns can be generated by capital appreciation. This is the theory of dividend inappropriateness. The stock price dips after the dividend payment, which means dividends come at a cost. A typical instance is Microsoft, which did paid no dividends for years during its high growth phase, but whose stock price shot up in the same period.
Dividend payment is a matter of company policy. A company paying small dividends is not necessarily essentially frail. Almost every company goes through a stage where it starts out burning rather than generating cash, and raises cash through public and rights offers. Then comes a phase of rapid expansion and increasing market share, where the firm tends to conserve cash for further expansion by paying low dividends. Reliance, Bharti Airtel, Pantaloons are in such a stage. In the mature stage, the company has achieved success, and generates more cash than it needs. That’s when it starts paying higher dividends. Some of the examples include Hindustan Unilever, ONGC, Castrol, and Tata Chemicals. Large dividends could point out a lack of growth opportunities, absence of major capital expenditure plans, or a sign that a company is unable to pull back profits into its business.
Dividend yield funds have been struggling with the problem of redemptions by investors following their miserable track record. The tendency of declining assets under management is common among funds launched in the past couple of years, but dividend yield funds have suffered more than most. Four of the six funds in this category have lost assets in the range of 64% to 97% from the time of launch. The combined corpus of dividend yield funds was a worthless Rs.1, 355 crore on August 31¿less than 1% of equity assets managed by Indian mutual funds.
The average dividend yield of the stocks in the portfolios of these funds was nearly 2.5%, as that of diversified equity funds stood at less than 1% as on August 31. UTI dividend Yield Fund, the biggest of the six funds, accounting for 50% of category assets, has fared the best, with a return of 31.50% over the past year. It was the merely dividend yield fund to outperform the Sensex. It has experience in sectors like banks, oil and gas, power and fertilizers. ONGC and Tata Chemicals have been the biggest favorites among dividend yield funds. ONGC records in the portfolio of five funds, while Tata Chemicals is present in the portfolio of four.
The presentation of dividend yield funds during bearish phases has been quite unimpressive, as they have more or less mimicked the downhill movement in market indices. On the other way round, during periods when the market is bullish or flourishing, dividend yield funds have shoddily or badly underperformed the growth in indices.
Investors in dividend yield funds would perform better to switch to other theme funds, like banking or infrastructure. Prospective investors may avoid investments in dividend yield funds altogether.
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