Dividend Yield funds: Should I Invest in it?

Mutual Funds / By /
Dividend yield fund

There seems to be a sudden interest in Dividend yield funds. This could be due to the New fund offer from HDFC Dividend yield fund. What is special about this category? is it worth investing in it? Let us find out.

Before we get into the topic of this post, you can check out fee-only financial planning if you are interested in the financial planning service that I offer. You can also get your mutual funds portfolio reviewed using the hourly plan.

You can check out my review of largecap funds.

Dividend Distribution tax

The dividend distribution tax has been abolished starting 1st April 2020. Please check out my post on this. As a result, companies do not have to pay the DDT when dividends are paid out. The effective rate for DDT was 17.472%. As a consequence, this year one can expect higher dividend payout as the entire amount allocated for dividend is paid out. This will make it attractive on paper to buy dividend yield mutual funds. However, companies are already substituting dividend with buyback. This is because promoters and large shareholders will now have to pay tax on the dividend received, making it unattractive. The amount distributed by companies through buyback is taxed at 20%.

Objective of the HDFC Dividend Yield fund

Below is a quote from the Scheme Information Document (SID) 

To provide capital appreciation and/or dividend distribution by predominantly investing in a well-diversified portfolio of equity and equity related instruments of dividend yielding companies. There is no assurance that the investment objective of the Scheme will be realized.

What do other mutual funds invest in? Do they not try to invest in companies which provide capital appreciation? Do they not invest in well diversified portfolio of companies? Dividend is a mechanism of returning cash to shareholders. Every fund manager does consider present dividend yield and future growth potential when they undertake the buy decision.

Is there any advantage by participating in the NFO? No. There is no advantage. In fact you will invest in a new fund without knowing how it has performed. You will be investing based on the SID. That is why the NFOs are pushed by distributors rather than being bought by investors. Let us consider the other funds which are available today in this category. The category is called “Equity-Thematic Dividend Yield”. There are a total of 6 funds in this category. The largest fund is UTI Dividend Yield fund with assets of 2,234 crores as of 30th October 2020. There are only 3 funds with assets greater than 500 crores. Let us study their performance. For comparison, UTI Nifty index fund has been added.

Risk Statistics comparison

Standard deviation of UTI dividend yield funds is lower than the other funds. However, Templeton India and ABSL fund’s standard deviation is not too less than the index fund. When we compare the Beta, we find that UTI is again the lowest and so will lose less when the market falls. It will also gain the least in a rising market. The alpha is where the dividend yield funds are lagging the index fund. The ABSL fund has a pretty pathetic alpha at -5.83. The max drawdown once again shows that UTI has lost the least in a falling market in Mar 2020. The expense ratio shows that all the dividend yield funds have a rather high expense ratio for their direct plans. The reason could be the low asset size. The index fund as expected has the lowest expense ratio at 0.1%. The 3-year return shows the index fund at the top, with ABSL showing a rather low performance at 1.71%. Let us check how does the returns look when we check out the 3 year rolling returns and 1 year rolling returns.

UTI Dividend Yield fund is clearly the better of the 3 dividend yield funds. It has outperformed the index fund at certain times, while under performing the index at some other times. There is no clear out performance demonstrated by the fund.

Conclusion

There is clearly no consistent out performance by the best performing Dividend yield fund. There is no need to pay a much higher expense ratio for a fund which does not beat the index consistenly. With no track record, HDFC could perform better than UTI or worse than ABSL. No one can tell. 

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