What is Dividend Yield Fund?
Equity and equity-related instruments have constantly given higher returns to the investors than other traditional investment instruments. Although equity investments yield capital gains, an asset class, they also deliver returns in dividends. A lot of companies in India share a part of their earnings with their investors by paying dividends. While paying dividends is not mandatory, many companies do it as it makes their stocks more attractive for investors and ensures that other investors consider buying their shares in the future.
However, investing in equities comes with the fear of identifying good stocks for the investors. You can still earn dividends even if direct equity investment is too risky and time-consuming for you by investing in dividend yield funds. Let us look at what dividend yield funds are and how they work
What are Dividend Yield Mutual Funds?
When you invest in an equity mutual fund, like a sectoral IT fund, it will invest your money across stocks of multiple IT companies. A dividend yield fund is also a type of equity fund where investment is made in the stocks of companies that regularly declare dividends. The main aim of dividend yield mutual funds is not capital appreciation but to identify and invest in stocks that offer regular dividends to the investors.
As a company can declare dividends if it is making healthy profits, dividend yield mutual funds only invest in companies with strong financials and excellent cash flow.
How Does the Fund House Select 'High Dividend' Companies?
Most fund houses select 'high dividend' companies by comparing their dividends yield with that of a benchmark index like Sensex or Nifty 50. For instance, the current dividend yield of Nifty 50 is close to 1.25. So, a dividend yield fund based on Nifty 50 will prefer investing in companies with a dividend yield of above 1.25.
Do Dividend Yield Funds Only Invest in High Dividend Companies?
Most dividend yield funds generally invest about 75%-80% of the capital in high dividend companies, and the rest is invested in stocks that the fund manager believes have high returns potential. The move is based on the belief that companies with low dividends yield or those that do not pay any dividends can provide good returns if they are undervalued and their fundamentals are strong. It also offers diversification to investors.
Who Should Invest in Dividend Yield Funds?
As the equity market witnesses a high level of volatility, the dividend yield funds are not recommended for individuals looking for stable returns with low volatility. While the funds invest in financially sound companies with an excellent track record, the returns may not be stable and can fluctuate between bull and bear cycles.
Furthermore, aggressive equity investors with a high-risk appetite should also avoid investing in these funds as stable, high dividend yield companies generally do not offer high returns based on capital appreciation. Pure equity funds like mid-cap and small-cap could prove to be a better choice for aggressive investors.
This type of fund is recommended for individuals who want to invest in equity but are not very comfortable with the market’s high volatility. However, limited exposure to dividend yield mutual funds is recommended for every investor aiming to build a diversified portfolio.
Conclusion
If you are planning to invest in dividend yield funds, consider funds with a decent corpus size, low historical volatility, and low expense ratio. Avoid making decisions based on the recent or current performance of the fund, as these funds could deliver high returns during the bull phase of the market but the returns can fall drastically during the bear phase. Hence, it is wise to focus more on the historical data and analyse the fund's performance during bull as well as bear phases to make a better decision.