The dividend effect on Indian equities is back. While not as much as that in the US, it is expected to play a major role. Since 1996, as much as 30% of investor returns have come as dividends.

This, if you had invested in Sensex stocks in the same proportion as their weightages in the index. So, while Rs 100 invested at the end of 1996 would have given you a return of 550%, the same after adjusting for dividends would have given 788%.

Interestingly, in the US, S&P 500 returns over the same period have been 69% and after adjusting for dividends as much as 117%. So, about 40% of US equity returns came as dividends. Dividend received on Sensex stocks has a compounding affect on long-term equity returns and in the Indian case as much as 2.5% of annual returns could have been chopped off if you are merely tracking Sensex.

If you are an index fund investor, you would benefit immensely from the dividend effect. This is because instead of tracking just Nifty or Sensex, they track Sensex total return index (TRI) or Nifty (TRI) which account for dividends. Earlier, index fund managers faced a tough time in reducing tracking error for index funds since they actually invested in Sensex stocks. This in turn meant they received dividends which led to divergence of returns from that of its benchmark index. But later by tracking Sensex or Nifty TRI, such tracking error has been done away with. This is a blessing in disguise for retail investors as they would be able to earn extra returns over the long term. Bloomberg data shows that, while over the 14 year period, Sensex gave a CAGR of 14.3%, Sensex TRI gave 16.9%. A 2.6% kicker to returns that is. While S&P 500 in turn gave a CAGR of 3.9%, while S&P 500 TRI gave annualised return of 5.7%.

As the equity market matures, it has historically been found that dividend contribution to overall equity returns has increased. US market for one is one clear example.

If Indian investors, wants a similar booster to returns, probably they should consider index funds from the mutual fund kitty. Afterall, Sensex TRI at 24,674 looks more promising than Sensex at 18,439.

One thing though investor has to be careful is to invest only in low cost index funds, since it has been found that many index funds back home charge higher fees than what is charged globally.