Looking for Best Dividend Paying Mutual Funds? Read This!

Some investors have a misconception that dividends in mutual funds are similar to dividends in stocks. In reality, unlike stock investing where dividends are directly paid out to investors, mutual funds do not directly pay out dividends. In other words, there is no such thing 'best dividend paying mutual funds'. Instead, the dividends received by mutual funds by way of investing in dividend-paying companies get reinvested in the scheme portfolio to benefit from the compounding of wealth.

To ensure clarity and avoid confusion, SEBI had even asked fund houses to rename the dividend payout option in mutual funds to IDCW option (Income Distribution Cum Capital Withdrawal) option.

[Read: All You Need to Know About IDCW Option in Mutual Funds]

For investors looking to benefit from companies that have the potential to provide growth through capital appreciation as well as regular income through dividends, Dividend Yield Mutual Funds are a suitable choice.

What are Dividend Yield Funds?

As per SEBI's definition, Dividend Yield Funds are mutual funds that are mandated to invest a minimum of 65% of their assets in equity & equity-related instruments of dividend-yielding companies.

The performance of Dividend Yield Funds is benchmarked against the Nifty Dividend Opportunities 50 - TRI Index. The constituents of the Nifty Dividend Opportunities 50 index are selected from within the top 300 companies based on the average free-float market capitalisation.

To select stocks, the fund managers of Dividend Yield Mutual Funds usually focus on stocks that have generated a high dividend yield. Apart from this criterion, the fund managers also give importance to parameters such as business fundamentals, industry outlook, absolute as well as relative valuations, growth outlook, and corporate governance.

Dividend-paying stocks are usually available in the large-cap space as they comprise mainly mature businesses with stable cash flows. The top holdings of Dividend Yield Funds predominantly include stocks in the Banking, Infotech, Consumption, and PSU segments.

The Indian mutual fund industry currently has nine Dividend Yield Funds (excluding a recently launched new fund offer), of which five have a track record of 10 years or more. In terms of performance, ICICI Pru Dividend Yield Equity Fund managed to consistently outperform its benchmark index, while other schemes have shown mixed trends in performance. When compared to the Nifty 50 - TRI index most schemes managed to generate higher returns compared to the index across time frames considered.

Should investors opt for Dividend Yield Funds?

A high dividend-yielding stock represents companies with steady growth in earnings, stable and scalable business models and in a mature phase with high cash flows can manage to share profits in the form of dividend payouts on a consistent basis. As a result of these strengths, dividend-yielding stocks tend to be less volatile and hence, less risky.

Thus, dividend yield stocks offer downside risk protection during volatile markets and are considered a good option in uncertain times. But since selecting such high-dividend yield stocks for an investor directly may not be easy, you may consider investing in dividend yield stocks through mutual funds.

Given the broader market rally over the past few years, the Dividend Yield Funds have benefitted substantially. However, it is important to note that just like any other strategy, Dividend Yield Funds too may witness phases of underperformance, especially when market rallies are driven by momentum. Moreover, remember that corporates may not pay out dividends consistently year after year, even if they are making profits, as it is not mandatory to pay out dividends. Further, poor earnings visibility, change in government policies, change in tax structure, etc., can affect dividend payouts.

Dividend Yield Funds are suitable for investors with moderate risk appetite. One should have an investment horizon of at least 3-5 years when investing in Dividend Yield Funds.

Note: This write up is for information purpose and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Returns mentioned herein are in no way a guarantee or promise of future returns. As an investor, you need to pick the right fund to meet your financial goals. If you are not sure about your risk appetite, do consult your investment consultant/advisor. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Registration granted by SEBI, Membership of BASL and certification from NISM no way guarantee performance of the intermediary or provide any assurance of returns to investors.

The securities quoted are for illustration only and are not recommendatory.

Watch this video to know about the top-rated equity funds across key categories:

We are on Telegram! Join thousands of like-minded investors and our editors right now.

DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.
Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.