What are Dividend Mutual Funds?
Dividend yielding mutual funds basically invest in companies paying high dividends. Companies have the option either to reinvest the net profit of the year or to distribute it among the stakeholders.
Dividend yielding mutual funds largely invest in those companies which distribute a large part of its profits. Such mutual funds may themselves declare high dividends.
Usually, these are government-owned companies as well as some private-sector companies which regularly pay back to the stakeholders in the form of a high dividend to maximize shareholders value.
There is another type of dividend which is paid by mutual funds, just like dividends paid by companies. However, such dividends are paid out when the investor picks the ‘dividend payout’ plan of a mutual fund. These dividends can only be paid from the profits booked by a mutual fund from its holdings.
Types of Dividend Yielding Mutual Funds
Dividend yielding mutual funds can be classified into 2 categories based on the asset allocation which are as follows:
- Dividend Yielding Mutual Funds (Equity)
- Dividend Yielding Mutual Funds (Debt)
If a divided mutual fund allocates more than 65% of the assets in equity class, it will be classified as Dividend Yielding Mutual Funds (Equity) otherwise the fund will be classified as Dividend Yielding Mutual Funds (Debt).
Apart from asset allocation pattern, these funds also differ from each other in terms of returns and tax treatment.
Top 3 Dividend Yielding Mutual Funds in India
|Fund Name||3-Year Return||5-Year Return||AUM|
|UTI Dividend Yield Fund||11.82%||11.12%||2,550 crore|
|Principal Dividend Yield Fund||16.79%||14.05%||207 crore|
|Templeton India Equity Fund||12.39%||12.64%||977 crore|
All Data as on May 10, 2019
UTI Dividend Yield Fund
Category: Equity – Dividend Yield
AUM: Rs 2,550 crore
Date of Inception: May 3, 2005
UTI Dividend Yield Fund has been in existence for 14 years now and has provided a return of 14.12% since its launch. It has also been managed by the same fund manager, Swati Kulkarni in this entire period. The fund invests in companies with relatively high dividend yields which is the ratio of dividend per share to the price per share.
A high dividend yield indicates a relatively high dividend compared to a company’s valuation and can be a strong signal to buy. This can imply a portfolio of relatively undervalued companies, representing a major opportunity for investors.
UTI Dividend Yield Fund has somewhat lagged its benchmark (Nifty Dividend Opportunities 50 Index TRI) over the past few years but the drop is marginal. The fund’s long-standing track record and experienced management should reassure investors.
The fund is dominated by technology, energy and FMCG rather than the financial sector which dominates the regular Nifty 50 Index.
|Returns||1 year||3 years||5 years|
Source: Value Research, Data as on May 10, 2019
Principal Dividend Yield Fund
Category: Equity – Dividend Yield
AUM: Rs 207 crore
Date of Inception: October 5, 2004
Principal Dividend Yield Fund is a relatively aggressive fund in the dividend yield category. It has about 41% of its corpus in mid and small cap companies. This has paid off over the long run with returns since launch (in 2004) of 11.73%.
However, higher allocation to the mid and small cap space also makes the fund somewhat volatile, compared to its benchmark, as the returns mentioned below indicate. Its fund manager Dimant Shah has been at the helm since December 2011. The fund also holds 59% of its assets in the large-cap space which gives it a balanced outlook in case of market volatility.
|Returns||1 year||3 years||5 years|
Source: Value Research, Data as on May 10 2019, Returns for Direct Plan
Get the List of Best Dividend Yield Funds for 2019
Templeton India Equity Income Fund
Category: Equity- Dividend Yield
AUM: 977 crore
Date of Inception: May 18, 2006
The fund has been consistent in its performance delivering 5-year returns at 12.64%. However, the fund has been a laggard in terms of its short term performance as compared to its benchmark Nifty Dividend Opportunity 50.
By allocating about 51% its asset to mid and small cap category stocks, the fund has adopted a quite aggressive strategy in terms of asset allocation which also makes the returns volatile. This has been reflected in its 1-year returns at -6.20% underperforming its benchmark.
Due to short-term performance jitters, recently, there was a change in the management board. The fund is now jointly managed by Anand Radhakrishnan and Lakshmikanth Reddy since January 2019. With the mid and small-cap space poised well to grow in 2019, the fund is expected to deliver well in the coming times.
*All Data as on May 10, 2019
Benefits of Investing in Dividend Mutual Funds
- A stream of high dividends can indicate steady cash-flows in the form of regular dividend income.
- Dividends are tax-free at the hands of the investor
- Dividend funds help minimize the market volatility risk and act as a hedge against market turmoil
Drawbacks of Dividend Mutual Funds
- A high dividend payout may indicate that the company does not have enough growth opportunities
- Dividends attract Dividend Distribution Tax (DDT) paid by the company at the time of declaring dividends. Hence, although the dividend is tax-free in the investor’s hands, the same is paid to him after deducting tax
- Dividends are not guaranteed and depend on the profits made by the company. Hence they cannot be absolutely relied upon for a regular income
- Dividend funds are likely to underperform the growth funds in a bullish market trend
Dividends in Debt Funds
Debt mutual funds also declare dividends. These dividends are paid from the income of debt funds which comes by trading bonds in the market or earning interest on bond/debt holdings. Debt Fund dividends are subject to a dividend distribution tax of 25%. After adding surcharge and cess, this works out to around 29%.
The tax is deducted before paying the dividend and hence the dividend is tax-free in the investor’s hands. Unlike equity dividends, debt dividends are much more regular and less volatile. However, the high rate of tax deducted make them relatively tax-inefficient.
Tax Treatment of Dividend Yielding Mutual Funds
|Fund Type||DDT Rate||Effective DDT Rate|
|Dividend Mutual Funds (Equity)||10%||11.68%|
|Dividend Mutual Funds (Debt)||25%||29.12%|
Dividends paid by equity mutual funds are subject to a dividend distribution tax (DDT) of 10%. The effective tax rate including the surcharge and cess comes at 11.68%. This tax is deducted at the time of paying a dividend and hence the dividend is tax-free in the hands of the investor.
Dividend distribution tax on non-equity funds such as money market, liquid, debt funds is 25%. Additionally, a 12% surcharge and 4% cess is levied on it which makes the effective DDT rate at 29.12%. Though dividends on non-equity funds are tax-free at the hands of investors, a very high rate of taxation makes them tax-inefficient.
Dividend Reinvestment and Dividend Sweep
Mutual Funds also offer dividend reinvestment and dividend sweep plans. Dividend reinvestment plans put back the dividend declared into the same mutual fund scheme.
For example, assume that Axis Bluechip Fund (Dividend Plan) declares a dividend of Rs 5 per unit and you hold 100 units of the fund. Hence you will get Rs 500. In case you are invested in a dividend reinvestment plan, the same Rs 500 will be automatically and immediately used to buy more units of Axis Bluechip Fund.
In a dividend sweep plan, Rs 500 will be used to buy units of another mutual fund scheme of Axis AMC (chosen by the investor). However, these options – dividend reinvestment and dividend sweep are extremely tax inefficient. This is because the tax is deducted every time the dividend is paid and reinvested/swept back.
As against this, the growth option of a mutual fund will also reinvestment the same money in the same fund. However, no tax is incurred in this reinvestment and hence its NAV increases at a faster pace.
Q. What is the difference between dividend yield and dividend option funds?
A. Dividend yield funds invest in companies which declare high dividends and are regular in terms of dividend declaration. On the other hand, the dividend option of a mutual fund simply gives an investor a choice of receiving returns in the form of a regular and steady flow of income in the form of dividends. Mutual funds which provide dividend option generate returns by means of capital appreciation only.
Q. What is the dividend distribution tax?
A. Companies distribute their profits among its stakeholders in the form of dividend declarations. Such dividends are treated as part of the income of stakeholders. The tax levied on such income is called as Dividend Distribution Tax (DDT). However, unlike other forms of income, where income tax is charged at the receiver of the income, DDT is charged on the dividend declaring company itself. This way, dividend income is tax-exempt at the hands of the recipient shareholder.
However, dividend income in excess to Rs. 10 lakh in a year is chargeable at 10% income tax for individuals, HUF, partnership firms or private trust.
Q. What is the current Dividend Distribution Tax (DDT) rate?
A. The government levies a Dividend Distribution Tax at 15% on companies declaring dividends. However, the effective rate of DDT including the surcharge and cess is at 20.36%.
The tax treatment of dividend yielding mutual funds is different for equity and debt funds. While dividend yielding mutual funds (equity) are taxed at 10%, dividend mutual funds (debt) at 25%.