Investors should consider dividend yield schemes now as low interest rates make high dividend yield stocks attractive
Given the evolving macro risks to earnings at the current valuation, volatility is here to stay. And with low interest rates and better prospects for the domestic cyclicals, retail investors should look at dividend yield schemes of equity mutual funds for higher tax-efficient returns. These schemes invest predominantly in stocks of dividend yielding companies with a preference for firms that have a consistent track record of paying dividends at the time of investment. These schemes are mostly market cap and sector agnostic.
Analysts say investors should consider dividend yield schemes now as low interest rates make high dividend yield stocks attractive. Moreover, due to change in taxation, many companies are opting for buy back which can be a good way to reward shareholders and improve the valuations of these companies. High dividend paying companies generally provide greater protection during market volatility and generate gains that are in line with the broader market when the market stabilises. Typically, the funds invest minimum 65% of the net assets in equity and equity-related instruments of dividend yielding companies.
Rationale for dividend yield schemes
Dividend yield is a financial ratio that shows how much a company pays out in dividends/buy back each year relative to its stock price. High dividend yielding companies tend to experience lower volatility, especially during underperforming equity markets. Companies that have high dividend yield have good cash flow in business, management commitment towards shareholders and have a higher return on equity.
Dividend paying companies are generally capital intensive businesses and annuity cash flow type businesses which are less volatile.
Companies paying dividends are more confident of sustainability of earnings, which means the ability to consistently pay dividends. These funds are suitable for investors looking for a diversified portfolio of dividend yielding stocks for capital appreciation over the long-term and equity investment with a fair amount of stability and relatively lower risk over medium to long-term.
Investors can also take advantage of tax arbitrage by investing through mutual funds compared to direct investing in dividend yielding stocks.
Analysts say high dividend yield companies trade at attractive valuations and as markets enter a broad-based rally, stocks at attractive valuations and strong fundamentals may provide better capital appreciation opportunities. Moreover, high dividend yielding companies also tend to have a higher asset base reflecting in price-to-book values. So, investors seeking differentiated portfolios as part of their medium to long-term investment horizon should now invest in dividend yield schemes of mutual funds.
Risks and rewards
Retail investors must keep in mind that dividend yield stocks are less liquid in terms of trading volumes in the stock markets and hence the impact cost and portfolio liquidity risk is higher. There could be time periods when dividend yield stocks may underperform relative to other stocks in the market which could impact the performance of the fund. Investors who do not want to take too much risk should invest in a dividend yield fund that has a higher allocation to large-cap stocks.
Like most funds, a dividend yield fund that has seen bull and bear phases of the market will be in a better position to offer stable returns as compared to the relatively new one. Investors must have an investment horizon of over three years and must be cautious of new schemes and those with a small corpus.