Invest in dividend yield funds for style diversity

Dividend yield funds have gained attention recently with SBI Mutual Fund’s new fund offer raising Rs. 3,600 crores.

- Sudipta Mitu

These funds primarily invest in stocks with higher dividend yield. Such funds make money from both the dividend received and from capital appreciation. The dividend yield strategy is a subset of the value strategy.

Past performance: Dividend yield funds languished in 2018 and 2019 but enjoyed a strong run in 2020 and 2021. 2022 again was another year of tepid performance. So far, they have given negative returns in the current calendar year. What their past record tells us is that investors must be prepared for periods of underperformance when opting for this category of funds.

While the one- and two-year category average returns of these funds are tepid, it has given very good returns over the three-year period and longer. The 10-year category average return is 12.76 per cent, which creates a strong case for investing in the category.

Investment style: To be selected by a dividend yield fund, a stock must have a higher dividend yield than a threshold level, say, that of the Nifty 50. Besides good current dividend yield, many fund managers also look at the stock’s prospects for earnings growth and the ability to generate free cash flow. Their logic is that companies with good earnings growth prospects can keep raising their dividends in the future.

Offer downside protection: Dividend yield funds invest in high-quality, stable growth companies with robust balance sheets. Such stocks, and hence the fund, tend to be less volatile in declining markets.

Restrictive mandate: However, these funds have a more restrictive mandate than flexi-cap funds. Many stocks in sectors like pharma, banking, etc do not pay out high dividend yields and hence are not picked up by these funds.