Dividend Yield Funds

• Dividend Yield Funds are best for moderate risk takers since these funds are relatively less risky as compared to small cap, mid cap and growth-oriented funds. So, during a downturn, they tend to fall less than the aforementioned funds. Investors who don’t want to be affected by volatility can invest in Dividend Yield Funds since the companies the funds invest in are generally capital intensive businesses that are less volatile.
• Investors who are not confident about picking out dividend yielding stocks on their own can opt for the mutual fund route.
• The funds provide a high return on investment in the long run. Hence, they are suitable for investors who want to stay invested for at least 5 years.
• These funds are good for investors who want to avoid a steep tax on dividends. When you invest in stocks that pay dividends, the dividends from stocks are taxed in the hands of the investors at a high marginal tax rate. In the case of the dividend yield funds, the dividends are taxed at a much lower rate.

• Dividend Yield Fund managers prefer to invest in companies for at least 5 years since these are equity mutual funds. Some fund managers favour blue-chip companies with a simple business model rather than businesses that have a complex business model.
• These funds have to invest at least 65% of their assets in equities. Moreover, they prefer to invest almost 50% of their assets in large cap stocks of mature companies.
• These funds help you beat the high taxes on dividends from stocks.
• High dividend stocks for the best Dividend Yield Funds are selected by the fund houses after looking at the earning capacity of the companies, depending on factors like brand equity and earnings per share (EPS) growth rate. Companies with high EPS and EPS growth rates will have more room for increasing their existing dividend payout.

• If you hold the fund for up to one year, the dividend gains get converted to capital gains. These are taxed at 10%, provided the dividend income is above Rs 5000. This rate is very low compared to the marginal tax rate on dividend payout from stocks which is 30% plus. Thus, Dividend Yield Funds are more tax-efficient than equities with the dividend payout option.

• Thematic Dividend Yield Funds invest at least 80% of their assets in stocks that are tied to a common theme. These funds are very risky since their success depends upon a theme playing out. If that doesn’t happen, then none of the stocks that the fund managers have invested in will perform well. These mutual funds are suitable only for experienced investors who typically allocate 10% of their portfolio to such funds. Thematic Dividend Yield Mutual funds are very volatile in the short-term, but if they are held for a period of 5 years, the risk comes down substantially.
• It is important for the companies to have sound management since the future earnings of the companies that determine the dividends depend on whether the decisions of the top management resonate with the ideology of the companies.
• When markets are rising, a dividend yield fund returns less compared to small cap, mid cap and growth-oriented funds.

• These funds result in higher tax-efficient gains.
• Dividend Yield Funds invest in companies that provide protection during market volatility. When markets are bearish, these funds perform better than small cap, mid cap and growth-oriented funds, so the investors benefit. In an underperforming equities market, high dividend yielding companies experience lower volatility, and once the market stabilises, they return gains that are in line with the market.
• Fund managers also invest in companies that are less risky. These companies don’t depend heavily on debt financing. Companies with high-interest coverage ratios are attractive for fund managers since such companies are generally not risky. The interest coverage ratio of a company determines whether it can pay off its debts. The ratio is calculated by dividing the earnings before income and tax by the company’s interest expense.

Since Dividend Yield Funds invest in several sectors, including IT, pharmaceutical, metals, consumer goods, construction, oil and gas, power, financial materials, chemicals and automobiles, you get good exposure to all the sectors. Moreover, some of these funds even have exposure to overseas stocks.

People who favour investing a small part of their portfolio in thematic dividend yield funds whose success depends on a theme playing out as expected should be aware that these funds delivered 23.14% returns in 2021. Their 3 year and 5-year returns were 17.9% and 14.07% per annum.