Dividend yield funds – Advantages and how to invest

Dividend yield funds form a specialized sub-category under equity mutual funds, with a specific focus on high dividend yield stocks. Dividend yield funds invest predominantly in stocks of companies that have a track record of paying regular dividends. As the name suggests, the fund managers of these schemes focus on the dividend yields of the underlying stocks while building their portfolios.

What are dividend yield funds?

Dividend yield funds predominantly invest in stocks of mature, blue-chip companies that have a consistent record of paying high dividends year-after-year. The fund managers analyze the dividend track record of companies before deciding to include their stocks in the fund’s portfolio. These funds aim to provide a regular income in the form of dividends along with the potential for capital appreciation over the long run. The fund managers assemble a portfolio of stocks across market capitalizations that offer attractive dividend yields. As per SEBI regulations, a dividend mutual fund must have a minimum of 65% of its assets invested in dividend paying stocks at any point in time.

Features of dividend yield funds

• Focus on high dividend yield stocks – The fund managers specifically target stocks with high dividend yield while constructing the portfolio. The dividend yield is calculated as the dividend paid per share divided by the current market price of the share.
• Dominant large cap bias – The portfolio allocation leans heavily towards large cap stocks as they have more stable cash flows and consistent dividend payment history compared to mid or small caps.
• Lower volatility – Owing to the mature, large cap nature of portfolio companies, dividend mutual funds experience relatively lower volatility compared to diversified equity funds.
• Regular income – Dividend pay-outs on a periodic basis act as a source of regular income for the mutual fund scheme, besides capital gains. However, dividends are not guaranteed and depend on the fund’s performance.

Advantages of dividend yield funds

• Regular income – The periodic dividend pay-outs provide a steady stream of income to the mutual fund scheme adding to its capital gains.
• Lower volatility – The mature, large cap tilt of the portfolio leads to lower volatility compared to diversified equity funds across market cycles. This reduces portfolio risk.
• Long term wealth creation – While providing regular income, dividend mutual funds also aim to deliver long term capital appreciation to create wealth.
• Diversification – Dividend mutual funds provide diversification to the equity portion of your investment portfolio on account of their distinct investment approach.

Who should invest in dividend yield funds?

Given their characteristics, dividend yield funds may be suitable for the following personas.

1. Conservative investors – The relatively lower volatility of these funds makes them appropriate for conservative investors who want equity exposure with lower volatility.
2. Retirees – Retirees looking for periodic dividends besides capital growth can consider investing in dividend yield funds and choose for IDCW (Income Distribution cum Capital Withdrawal) payout option while investing.
3. Income seekers – Investors looking for regular income through mutual fund investments can opt for dividend yield funds and choose for IDCW (Income Distribution cum Capital Withdrawal) payout option while investing.

However, investors with a high risk appetite looking for aggressive growth may find the potential capital appreciation of dividend yield funds limited and may prefer diversified equity funds instead.

Conclusion

Dividend yield funds can be a good investment option for conservative investors looking for regular income along with the potential for long-term capital appreciation. However, you should be aware of their concentrated portfolios and limitations in terms of capital growth compared to diversified equity funds before investing. Selecting a reputed dividend yield fund in line with your risk profile and investment goals is key to benefit from their advantages. Investing through the direct plans of AMCs online is the most efficient way to gain exposure to dividend yield funds.