Please avoid dividend yield funds

With the markets spiraling northwards and investors displaying an affinity for market-linked investment avenues, the mutual fund industry has "blossomed" over the years. Asset Management Companies have done their bit by launching a plethora of offerings.

Consequently, investors now have a greater variety to choose from. At Personalfn, we have had the opportunity to watch the industry at close quarters. While some of the offerings can truly add value to investors, others (rather suspiciously) seem to be the result of fund houses' need to augment their assets under management.

We thought this would be a good opportunity to take a closer look at some of the variants in the mutual fund industry. As the first in a series of articles, we profile the category of dividend yield funds.

Dividend yield funds are diversified equity funds, which invest predominantly in stocks with a high dividend yield. Dividend yield is defined as the dividend per share divided by the stock's market price at the time of investment. These funds draw from the investment strategy "Dogs of the Dow"; this strategy involves picking five highest yielding stocks of the Dow Jones Industrial Average.

Traditionally, stocks with a high dividend yield are considered to be attractive investments, as they tend to be stable performers over longer time frames.

Dividend yield funds are of relatively recent origin. The criterion for dividend yield is generally pre-defined by the mutual fund. For instance, UTI Dividend Yield Fund has defined dividend yield as 'high' if the same is greater than that of the Nifty.

Some of the fund houses, which have dividend yield funds in their offerings, include Birla Sun Life Mutual Fund, Principal Mutual Fund, Tata Mutual Fund, ABN AMRO Mutual Fund, UTI Mutual Fund and ING Vysya Mutual Fund.

Among these funds while Birla Dividend Yield Plus has a 3-Yr track record, others like Principal Dividend Yield, Tata Dividend Yield and UTI Dividend Yield have been in existence for slightly over a year. For the purpose of our discussion, we have considered funds with a minimum 1-Yr track record.

We decided to face-off dividend yield funds amongst themselves and find out how they have fared against conventional diversified equity funds.

Dividend Yield Funds Vs Diversified Equity Fund

Portfolio Strategy

At Personalfn, we believe that a diversified equity fund should hold no more than 40 per cent of its assets in the top 10 holdings; a top-heavy portfolio can make the fund a candidate for volatility during a downturn in markets. To that end, some of the dividend yield funds under consideration qualify as concentrated.

UTI Dividend Yield Fund had the most concentrated portfolio with 58.3 per cent of its assets in the top 10 stocks, while Principal Dividend Yield had the most well-diversified portfolio with 42.5 per cent in the top 10 stocks.

A possible reason for the relatively high concentration levels across funds could be the restrictive investment mandate of dividend yield funds. Unlike conventional diversified equity funds that have a free-flowing investment style, dividend yield funds can only invest in stocks, which meet their pre-determined criteria.

Performance
The performance of dividend yield funds has been disappointing on returns parameter. Over the last 12 months, all the funds in this category have failed to outperform their respective benchmark indices. There is little differentiating the performances of dividend yield funds. Principal Dividend Yield Fund with a return of 34.2 per centover 1-Yr is the best performing fund, followed closely by UTI Dividend Yield (34.1 per cent). Tata Dividend Yield (33.1 per cent) and Birla Dividend Yield Plus (30.3%) occupy third and fourth positions respectively.

Only Birla Dividend Yield Plus (48.1 per cent) has a 3-Yr track record (which is ideal for evaluating the performance of diversified equity funds). However, the fund has failed to outperform its benchmark index i.e. S&P CNX 500 (50.0 per cent).

Comparing the performance of dividend yield funds with that of diversified equity fund makes the scenario clearer for the investor and grimmer for dividend yield funds. Over the 1-Yr and 3-Yr periods, funds from the dividend yield category lag their diversified equity funds peers.

Despite holding the promise of being unique investment propositions, dividend yield funds have failed to deliver. Anyway you look at it, they have been underperformers. They have even underperformed their own benchmark indices by a significant margin.

As a result, they have given investors no reason to choose them over well-managed diversified equity funds.

In our view, investors should consider giving dividend yield funds a miss and instead invest in diversified equity funds, which in any case also invest in high dividend yield stocks.