Are Dividend Yield Funds Worth Your Money?

In theory, the basic purpose of investing in a stock is to participate in the profits earned by a company. The objective of capital appreciation is secondary.

But in reality, investors tend to largely care about capital appreciation. They treat dividend income as a bonus, if there is any.

The dividend yield is a function of the amount of cash dividend a company pays as a percentage of its market price.

Some Indian companies pay dividends generously. As a result, their dividend yields are better than the interest rate on 3-year bank deposits.

Typically, high dividend-paying companies are mature businesses. They plough back less profits for growth. They often trade at discounted valuations vis-a-vis the valuations of the broader markets and fast-growing companies within their sector.

"If you want the recipe for getting rich in the stock market, here it is: Find stocks with above-average appreciation potential and safe and growing dividends, and buy them at attractive prices." - Charles B. Carlson, the CEO of Horizon Publishing and Horizon Investment Services, and author of The Little Book of Big Dividends: A Safe Formula for Guaranteed Returns.

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Table 1: Companies with high Dividend Yields

Company	Dividend Yield (%)
Indus Towers	10.0
IOC	9.5
Coal India	8.5
Hindustan Zinc	6.7
Britannia	5.0
Hero Motocorp	4.4
ITC	4.1
Bajaj Auto	4.0
NTPC	3.9
Power Grid	3.8

Data as of 2 May 2022
(Source: Equitymaster Stock Screener)

As exhibited in Table 1, a majority of the companies with exceptionally high dividend yields are public-sector companies operating in the commodity-driven cyclical business.

In a few cases, the current dividend yields look attractive because the stock prices are depressed, while for the others a high dividend payment may not be sustainable.

As depicted in Graph 1 below, the Nifty Dividend Opportunities 50-Total Return Index (TRI) has outperformed the Nifty 50-TRI over the last one year. The Nifty Dividend Opportunities 50 tracks the performance of the top 300 companies on average free-float market cap and average daily turnover.

Based on this, stocks with higher dividend yields are selected and the index rebalancing happens once a year.

Graph 1: Nifty Dividend Opportunities 50-Tri Vs Nifty 50-TRI

As of 29 April 2022, the Nifty Dividend Opportunities 50 quoted at a Price-to-Earnings (PE) multiple of 12.35x and offered a dividend yield of 3.52%. Whereas the Nifty 50 traded at a PE of 22.01x and had a dividend yield of 1.16%.

Moreover, the Nifty Dividend Opportunities 50-TRI has been less volatile historically compared to the Nifty 50 and has a low beta.

Investors seeking to take exposure to high dividend-paying companies through the mutual fund route, often consider Dividend Yield Funds.

According to SEBI's categorisation norms, any equity mutual fund scheme predominantly investing in dividend-yielding stocks is classified as a dividend yield fund.

In practice, Dividend Yield Funds tend to focus on investing in a portfolio of companies that pay good dividends and also have a scope for capital appreciation.

With falling interest rates on Fixed Deposits (FDs) during the pandemic, Dividend Yield Funds suddenly looked attractive to conservative investors looking to beat the FD interest rates.

In January 2020, Dividend Yield Funds had 475,387 folios and the AUM (Assets Under Management) of Rs 4,416 cr. The folio count increased to 567,533 as of March 2022 and the AUM to Rs 9,819 cr, according to the data published by the Association of Mutual Funds in India (AMFI).

Table 2: Are Dividend Yield Funds True to their Label?

Scheme Name	Scheme PE (x)	Scheme PBV (x)	Scheme Dividend Yield (%)
Templeton India Equity Income Fund	20.97	4.53	4.03
UTI Dividend Yield Fund	28.68	7.29	3.56
Aditya Birla SL Dividend Yield Fund	28.95	6.39	3.56
HDFC Dividend Yield Fund	27.30	5.57	3.08
IDBI Dividend Yield Fund	38.92	7.51	1.72
Sundaram Dividend Yield Fund	31.77	5.96	1.69
ICICI Pru Dividend Yield Equity Fund	33.62	4.36	1.51
NIFTY DIV OPPS 50	12.35	3.35	3.52
Nifty 50	22.01	4.37	1.16

Data as of 2 May 2022
(Source: NSE, PersonalFN Research)

We considered all Dividend Yield Funds with at least a year of track record. We found only 3 of them offered decent dividend yield compared to the Nifty Dividend Opportunities 50 Index.

Nevertheless, all Dividend Yield Funds had better dividend yields vis-a-vis the Nifty 50-TRI.

Table 3: How have Dividend Yield Funds Performed on a Risk-Adjusted Basis

Scheme Name	Returns Absolute (%)	CAGR Returns (%)				SD Annualised	Sharpe
	1 Year	2 Years	3 Years	5 Years	7 Years
Templeton India Equity Income Fund	29.0	50.3	22.0	15.7	14.2	20.85	0.25
IDBI Dividend Yield Fund	19.7	32.7	19.5	-	-	18.96	0.24
ICICI Pru Dividend Yield Equity Fund	35.5	48.0	18.0	11.9	13.3	22.78	0.20
Aditya Birla SL Dividend Yield Fund	21.8	35.3	16.6	8.7	9.6	21.23	0.19
Sundaram Dividend Yield Fund	18.0	32.8	16.6	14.4	14.1	19.61	0.19
UTI Dividend Yield Fund	20.2	34.3	16.4	12.9	12.2	19.63	0.20
HDFC Dividend Yield Fund	32.3	-	-	-	-	13.09	0.57
Category Average	25.2	38.9	18.2	12.7	12.7	19.45	0.26
NIFTY 500 - TRI	20.5	36.9	16.5	13.6	13.1	22.44	0.18
NIFTY DIV OPPS 50-TRI	19.6	30.0	10.5	9.0	9.1	19.56	0.15

Data as of 02 May 2022
(Source: ACE MF, PersonalFN Research)

Over the last 3 years, Dividend Yield Funds have outperformed not only Nifty Dividend Opportunities 50-TRI but also the broader market index Nifty 500-TRI.

Their risk-adjusted returns, as denoted by the Sharpe Ratio, have been better than their benchmark indices. So, some have rewarded investors well.

The top-3 performing schemes in the Dividend Yield Funds sub-category are:

Scheme #1: Templeton India Equity Income Fund

Launched in May 2006, Templeton India Equity Income Fund aims to provide a combination of regular income and long-term capital appreciation by investing primarily in stocks that have a current or potentially attractive dividend yield, by using a value strategy.

The average dividend yield of the fund over the last 1 year has been 4%, making it a truly Dividend Yield Fund.

Table 4: Top 10 Stock Holdings of Templeton India Equity Income Fund

Stocks	% of Assets
Infosys Ltd.	7.8
Power Grid Corporation Of India Ltd.	7.1
Embassy Office Parks REIT	4.5
Tata Power Company Ltd.	4.5
Brookfield India Real Estate Trust REIT	4.3
NTPC Ltd.	4.2
Hindustan Unilever Ltd.	4.2
ITC Ltd.	4.1
Bajaj Auto Ltd.	3.6
NHPC Ltd.	3.4

Data as of 31 March 2022
(Source: ACE MF, PersonalFN Research)

As of 31 March 2022, the fund held 96.1% of its portfolio in equity and equity-related assets while the cash and cash equivalents accounted for 3.9% of its portfolio. The fund held 37 stocks and its top 10 holdings made up 44.8% of the portfolio.

The fund has also taken exposure to the international markets and invested in overseas equities. As of 31 March 2022, Templeton India Equity Income Fund invested in 7 foreign companies, such as Unilever PLC, Xtep International Holdings Ltd., Novatek Microelectronics Corp. Ltd., Xinyi Solar Holdings Ltd., etc.

These companies are operating in niche segments of renewable and energy electronics, which accounted for 10.1% of its portfolio.

The fund has invested heavily in IT, utilities and FMCG companies and has allocated 8.9% of its portfolio to Real Estate Investment Trusts (REITs) as of 31 March 2022.

In recent times, the fund has added HCL Technologies, Apollo Tyres and ICICI Bank to its portfolio. It has been gradually increasing its exposure to utility companies and energy stocks.

Scheme #2: IDBI Dividend Yield Fund

Launched in December 2018, IDBI Dividend Yield Fund aims to offer long term capital appreciation and/or dividend distribution by investing predominantly in dividend-yielding equity and equity-related instruments.

The average Dividend Yield of the fund over the last 1 year has been just 1.8%, a tad higher than the Nifty 50-TRI. So, we can say that the fund hasn't remained true to its label always.

As of 31 March 2022, the weightage of equity and equity-related assets was 98.5% in the portfolio while the remaining were cash and cash-equivalent assets. The fund invested in 38 stocks with top-10 stocks accounting for 46.3% of its portfolio.

Table 5: Top 10 Stock Holdings of IDBI Dividend Yield Fund

Stocks	% of Assets
Infosys Ltd.	11.5
Tata Consultancy Services Ltd.	5.9
Carborundum Universal Ltd.	4.4
Power Grid Corporation Of India Ltd.	4.1
Atul Ltd.	4.1
ICICI Bank Ltd.	3.9
Divi's Laboratories Ltd.	3.3
Titan Company Ltd.	3.2
Bajaj Finance Ltd.	3.1
Tech Mahindra Ltd.	2.8

Data as of 31 March 2022
(Source: ACE MF, PersonalFN Research)

By and large, the fund has followed the buy-and-hold strategy and has refrained from churning the portfolio frequently.

While it has invested in PSU stocks yielding high dividends, its core portfolio also comprises stable non-cyclical companies from IT, pharma, and consumer-facing businesses.

Scheme #3: ICICI Pru Dividend Yield Equity Fund

Launched in May 2014, ICICI Prudential Dividend Yield Equity Fund aims to generate medium to long term capital gains and/or dividend distribution by predominantly investing in a well-diversified portfolio of equity and equity-related instruments of dividend-yielding companies.

Although the present dividend yield of the fund has been just 1.5%, it has ranged from 1.5% to 3.5% over the last one year.

This indicates that either the stocks in the portfolio have been re-rated which has resulted in a drop in the yields or the fund may have shifted its focus a bit away from high dividend stocks.

Table 6: Top 10 Stock Holdings of ICICI Prudential Dividend Yield Equity Fund

Stocks	% of Assets
Infosys Ltd.	9.1
Axis Bank Ltd.	6.3
Bharti Airtel Ltd.	5.4
Sun Pharmaceutical Industries Ltd.	5.1
HDFC Bank Ltd.	4.5
SBI Life Insurance Company Ltd.	4.5
HCL Technologies Ltd.	4.5
Larsen & Toubro Ltd.	4.4
Mahindra & Mahindra Ltd.	4.3
Tech Mahindra Ltd.	3.5

Data as of 31 March 2022
(Source: ACE MF, PersonalFN Research)

As of 31 March 2022, the fund has invested 91.6% of its assets in equity while the remaining were cash and cash equivalents. The fund's portfolio comprises 41 stocks with top-10 stocks accounting for 51.5% of the portfolio.

Lately, the fund has been adding financials and midcap IT companies. Interestingly it's been selling ITC on rallies and buying it again on dips.

These and other portfolio preferences suggest that the fund's nature has always been opportunistic. It is invested in ConocoPhillips, an American multinational engaged in hydrocarbon exploration and production.

Although the dividend yields of a few schemes such as Aditya Birla SL Dividend Yield Fund and UTI Dividend Yield Fund have constantly remained in the range of 3.4% to 3.6%; their performance visa-a-vis the leading performers in the category has been lacklustre of late.

This makes us believe that except for Templeton India Equity Income Fund no other fund in the category has remained true to its label and convincingly outperformed its peers as well as the broader markets.

Although Templeton India Equity Income Fund has exposed its investors to higher risk than the category average, it has handsomely rewarded investors on a risk-adjusted basis.

The outlook for the Dividend Yield Funds

After maintaining the status quo for the last two years, the RBI raised the policy repo rate by 40 basis points (bps) in a surprising move on 4 May 2022.

This was a call to action to curb spiralling CPI inflation which shot up much beyond the RBI's comfort range of 4%-6% before it causes second-round effects.

Further, the Monetary Policy Committee (MPC) also decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

In other words, this means borrowing rates and bank FD interest rates will increase from now on. Moreover, if inflation continues to inch up further, it could adversely affect the dividend yields of companies and in consequence the performance of Dividend Yield Funds.

Rising input and financing costs eat into the profit margins of companies. Unless they can pass on the higher costs to their customers, the distributable surplus available with them gets eroded.

Many Dividend Yield Funds hold considerably high exposures to FMCG companies which are facing inflationary pressures.

It remains to be seen how the quantum of dividend income earned by Dividend Yield Funds gets affected on account of falling markets, rising inflation, and increase in interest rates.

On the flip side, under a high inflationary scenario, commodity-driven stocks with higher dividend yields may continue to remain strong.

Moreover, many companies that pay high dividends are either reasonably valued or generate high cash flows.

In challenging times, companies with a good dividend track record and appealing dividend yields may be preferred by investors.

Plus, some of the worthy Dividend Yield Funds may reward investors well as against the risk taken.

Disclaimer: This article has been authored by PersonalFN exclusively for Equitymaster.com. PersonalFN is a Mumbai-based Financial Planning and Mutual Fund research firm known for offering unbiased and honest opinions on investing.