USP of Dividend Yield Fund

Rohit Shimpi, who will be the fund manager of SBI Dividend Yield Fund, says that this is a huge fund category globally, especially in markets like the US and Europe.

For example, the Vanguard High Dividend Yield ETF, which trades on US exchanges, has assets under management (AUM) of $50 billion, or 4 trillion at current exchange rates. SPDR S&P Euro Dividend Aristocrats UCITS ETF with AUM of €1,038 million, listed on a German exchange, or 9,102 crores.

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Currently, there are eight Dividend Yield Funds in India with the combined AUM 10,414 crores.

How do these funds work

The portfolio of a dividend yield fund consists of stocks that have a consistent track record of paying dividends to their shareholders. The dividend yield of a company is the dividend paid by the firm as a percentage of its share price. For example, if a company has paid a dividend 30 (Interim Dividend) in a financial year Final dividend of 5 more 25) And the share price of the company is 600, its dividend yield is 5%.

The dividend yield of both Nifty 50 and Nifty 500 as of January 31 was 1.4%, while the yield of Nifty Dividend Opportunities 50 Index was 3.6%.

Fund managers also look for a stock’s earnings growth potential, but consistency of dividend payments usually takes precedence.

Dividend yield funds invest in mature businesses that have the potential to generate consistent free cash flow. Free cash flow is an important parameter for dividend yield funds, as companies can distribute dividends from the available cash on their balance-sheets. Free cash flow is defined as the cash that remains with the company after meeting its financial obligations – operating and capital expenditure – in a financial year. Businesses with high free cash flow also tend to be cash-rich.

The top sectors in the portfolio of these funds are Information Technology (IT), Banks, Fast Moving Consumer Goods (FMCG) and Power Utilities.see table, Many of the companies in these sectors run mature businesses with cash-rich balance-sheets, which is why these funds have significant exposure to these sectors.

Apart from large cap tilt, these funds also take some exposure to mid and small cap stocks, which offer high growth potential.

For example, Aditya Birla Sun Life Dividend Yield Fund has 17.7% exposure to mid cap stocks and 25.2% exposure to small cap stocks. UTI Dividend Yield Fund has 14.9% exposure to mid cap stocks and 15.4% exposure to small cap stocks.

Among the existing dividend yield funds, Franklin India’s Templeton India Equity Income Fund is unique as it also has some exposure to stocks listed on foreign exchanges.

past performance

In terms of recent performance, Dividend Yield Funds have outperformed Flexi Cap Funds. Over a three year period, Dividend Yield Funds have given a category average return of 18.8% Compounded Annual Growth Rate (CAGR) as compared to 14% CAGR returns given by flexi cap funds.

But this can be attributed to the market favoring value stocks over growth stocks, which has indirectly helped dividend yield stocks. These stocks typically trade at lower price-to-earnings (P/E) multiples than growth stocks, which trade at relatively higher valuation multiples.

“In the recent period, value stocks have outperformed growth stocks. Value stocks had massively underperformed in the past decade. Hence, some rebound was expected in these stocks,” said Amar Ranu, Investment Products & Advisors , says Anand Rathi Head of Shares and Stock Brokers.

Anish Teli, managing director, QED Capital Advisors, says the equity market has been largely flat over the past few years and has also been volatile. “On the contrary, due to the underlying nature of dividend yield stocks, the category has performed well as these stocks are less prone to market volatility and uncertainty. Due to this, dividend yield funds have performed better than flexi cap funds.

During volatile periods, dividend-paying stocks may fall short. For example, when the Nifty 50 index declined by 38% during the post-Covid correction in 2020 (between January 14, 2020 and March 23, 2020), the Nifty Dividend Opportunities 50 index declined by 33%.

However, during market rallies, these stocks may underperform as there is a preference for high growth companies over value stocks during such periods.

For example, between March 23, 2020 and October 18, 2021, when the Nifty 50 Index climbed 142%, the Nifty Dividend Opportunities 50 Index was up 128%.

The analysis of five year CAGR returns since February 21, 2018 shows that Dividend Yield Fund has underperformed Flexi Cap Funds with an average CAGR return of 10.7% as against 12.1% CAGR returns delivered by Flexi Cap Funds.

dividend yield vs price

While similar to value stocks in many ways, stock and sector selections differ in the focus on free cash flow.

“While there are similarities, there are also differences. For example, sectors such as FMCG are unlikely to be overweight in the value category, as these companies trade at relatively high P/E multiples,” says Shimpi.

“The focus in a dividend yield strategy is to find companies that offer free cash flow. In the value category, the strategy may be to look for companies where free cash flow may not be great at the moment, but have inherent value. These funds can go into sectors like construction, real estate etc.”

From a volatility perspective, a dividend yield strategy is likely to be less volatile than a value strategy.

For example, the Nifty Dividend Opportunities 50 Index had a standard deviation of 15.8 over a 1-year period while the Nifty 50 Value 20 Index had a standard deviation of 16.6. Over a 5-year period, the Nifty Dividend Opportunities 50 Index had a standard deviation of 17.2, while the Nifty 50 Value 30 Index had a standard deviation of 17.9.

In dividend yield funds, the fund managers also look for stocks where dividends can grow over time.

Should you invest?

While the focus is on dividend yield, these funds can also take advantage of a stock’s growth potential.

Because these strategies limit downside during market corrections, they can make for a less volatile option for an investor.

Also, dividend yield funds tend to participate less in market movements than diversified equity funds over the long term. Periods of outperformance can occur when the market preference shifts towards value stocks, as seen in the recent period.

When it comes to investing in equity markets, longer investment horizons can reduce the impact of market volatility.

An equity investor with a long-term investment horizon can look for options in a diversified fund category like flexi cap. Flexi cap funds are not constrained by any strategy—dividend yield, value or growth, or even a market cap limit. Fund managers can include any stock or sector in their portfolio which can help the fund generate healthy returns.

There are flexi cap funds that have demonstrated the ability to manage volatility during market corrections.

However, dividend yield funds may do well in the near term. “Given the recent bouts of volatility in the markets over the past few months, near-term choppiness can be expected for the broader markets, with limited scope for any surprises to the upside. Dividend yield funds can be expected to hold well during this period,” explains Alekh Yadav, head of investment products at Sanctum Wealth.

Such funds may be part of an investor’s satellite allocation or strategic allocation, but diversified equity funds should still be part of an investor’s core portfolio.