Dividend Yield Funds

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Around 125 companies rewarded their shareholders with dividends, in some cases interim dividends, since the beginning of this year. Prominent names in the list include public sector units such as Oil India, NMDC, ONGC and some multinational companies like Abbott India, Aventis, and Bosch. Naturally, some people are once again waking up to the charm of dividend paying stocks and dividend yield strategy to build wealth. Regular cash payouts in the form of dividends always had takers in the market, especially those who were looking for regular income as well as capital appreciation over a long period of time.

If you like the idea, you can take a look at stocks with strong dividend paying record or invest in dividend yield mutual fund schemes. Investors should look at dividend yield funds for good returns in the long term as dividend yield strategy aims at buying good underlying businesses paying regular dividends at attractive valuations.

What is Dividend Yield ?

For the uninitiated, dividend yield can be calculated by dividing the dividend per share by the prevailing price of the stock. In a bad market, dividend yield goes up as the stock prices fall, making such an attractive bet. The fund manager tries to cash in on the opportunity to buy under-priced stocks. Fund managers can buy a stock when it is cheap on the dividend yield basis and can sell it as it turns dear if dividend yield falls with rising prices, thus capturing profits for investors. Such a fund will have companies with sound financials and consistent dividend paying record. That means, apart of the regular dividends, you can also be reasonably sure of the capital appreciation over the long-run. Sure, if you have the stock picking skills, you can replicate the same strategy to build your own portfolio. Otherwise, stick to a good mutual fund scheme.

A word caution for those who are going to do it on their own. Don't just pick up any stock that has recently declared dividend and has attractive dividend yield. This is because some companies may announce special dividend to distribute a one-time gain to investors or for achieving a milestone like golden jubilee year or sales of $1 billion. For example, Gujarat Gas recently declared a special dividend of . 12, and Bosch paid a special dividend of . 85 in June 2011. So when you are calculating dividend yield, don't forget to exclude such special dividends. One can choose to invest in stocks quoting at or above, say, an absolute number of 3% or use a relative yardstick such as dividend yield of the Sensex. Also, look into the business growth of the company. Remember, you are buying stocks to create wealth and not just to earn regular income in the form of dividend year after year.

The Funds

There are some dividend yield equity mutual fund schemes you can choose from. UTI Dividend Yield Fund (. 3,451 crore) is the largest scheme in the category, followed by Birla Sunlife Dividend yield Plus Fund (. 1,073 crore) as quarterly average assets under management as on December 31, 2011. Most schemes have managed to outperform the broad market represented by the BSE Sensex in the last five year (See Table). Birla Sunlife Dividend Yield Plus Fund has been the best performing fund in the category with 16.24% returns over last five years, according to Value Research, a mutual fund tracking entity.

 
These funds are more stable compared to the broader market. Risk, measured by standard deviation, in these funds are typically low in the long-term. Most of these schemes have scored better than Sensex over a three-year timeframe, with lower standard deviation. It means fund managers could ensure less risky portfolios here compared to broader markets. Though the picture is great on both returns and risk fronts, there are certain downsides.

Down sides

Not all good companies pay regular dividends. For example, high growth companies may not declare regular dividends to conserve capital. Also, capital intensive businesses prefer to conserve capital which in turn results in low or no dividends. A dividend yield fund cannot invest in such stocks. In a sharp recovery in markets, stock prices of capital intensive businesses may see quick up move resulting into relative underperformance of dividend yield funds in the short term, but over the long term these schemes deliver healthy risk-adjusted returns. A look at the long-term performance proves his point. Though capital-intensive businesses come in demand in economic upturn, they also suffer the most in recessionary times. Whereas, established businesses paying regular dividends always remain on investors' radar.

 

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Some of the best Tax Saving Mutual Funds available ( ELSS Mutual Funds )

1. HDFC TaxSaver
2. ICICI Prudential Tax Plan
3. DSP BlackRock Tax Saver Fund
4. Birla Sun Life Tax Relief '96
5. Reliance Tax Saver (ELSS) Fund
6. IDFC Tax Advantage (ELSS) Fund
7. SBI Magnum Tax Gain Scheme 1993
8. Sundaram Tax Saver