Why you should not invest in equity funds for dividends

May 8, 2017 . Mutual Fund Research Desk

We have seen investors invest in a fund because the fund is expected to declare dividends. They also opt for dividend option as a means of regular cash flows. We are of the view that choosing the dividend option for these reasons is not prudent.

Before we explain why, let us recap how dividends are paid by mutual funds. A fund manager can declare dividends only from the realised profits. By this we mean that, in an equity fund, a fund manager should have either sold stocks at a profit and use such profits to declare dividends; or it may also have cash in the form of dividends received from the stocks it holds and use it to declare dividends. Similarly, in a debt fund, the interest or the coupon received in the fund can be declared as dividend or any profits booked by selling an underlying instrument can be declared as dividend.

You can read our previous article on how dividends are declared

In this article we will be looking at why it is not the most optimal of options to be investing in dividend schemes of equity funds especially when in requirement of regular cash flows.

Dividend payment by equity funds
Let us look at some numbers to understand this. Take the 285 equity funds that make up the large-cap, midcap, small cap, diversified, thematic, index and international fund categories. We took these categories as they are the often chosen ones. Then consider the past five years, a period which has seen market highs and brief corrections – a good period to judge dividend trends for equity funds.
In the last five calendar years, on an average dividends were declared 2.5 times. That means only 50% of the time in these 5 years were dividends declared. When we consider the quantum declared, only Rs 4.7 per fund on an average has been declared over the five years. This works out to less than a rupee of dividend declared per year across all the funds.

And remember while dividend at Rs 4.7 might seem like 47% on the face value of Rs 10, that would not be the price of your fund. For example the yield of a fund you bought at an NAV of Rs 200 may be just 2%. Our purpose behind quoting the quantum is to let you know that the amount given back is not high enough for you to generate meaningful income.

Let us drill down further. In 2016, only 68 equity funds declared dividends. In 2015, 150 funds had declared dividends.

This number was 143 in 2014, 103 funds in 2013 and 106 in 2012. Equity funds usually declare dividends only once a year. But even where funds declared dividends more than once, the sum of these dividends was still around the category average.

Dividend in equity funds is thus sporadic. This is so since the declaration of dividends is entirely at the discretion of the fund manager. Both the decision of when to and how much to declare is decided based on market conditions and the realised profits that a fund has.

Investing before dividend declaration
While fund houses are not supposed to announce a dividend declaration too ahead, investors who get to know about such ‘news’ invest in a fund thinking that they will make some immediate profits. The fact is that they only get back a part of their own money. This is because, dividends are only stripped from your own NAV.

For example, in the case of Franklin India Bluechip, on the record date, the NAV was 38.6139 (as on 5th Feb 2016). Once a dividend of Rs 3.5 was declared on a face value of 10, the NAV ex-dividend fell to 34.6706 on 8th Feb 2016 factoring the dividend paid.

In other words, your own money would have come back to you had you invested in just before the dividend declaration.

Given the erratic nature of dividends, the small quantum, and the fact that you do not make money by simply buying a fund before dividend declaration, dividend is not the best of options in equity funds.
Also, remember, equity funds are meant to build your wealth. That means you should allow your money to stay and grow. Once you take them out as dividends, it goes into your bank pool for spending. At best, in risky options such as sector funds, which are dependent on their sector cycles, dividend option may help take out some money when they going is good.

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