A dividend yield fund is a type of an equity fund where investment is made in the shares of those companies that regularly declare dividends. The major objective of dividend yield mutual funds is not capital gain or appreciation but dividends. Asset management companies invest in companies with strong financials, excellent cash flow and regular dividend pay-out.

The criteria is not only high dividends but also a high dividend yield. This means if a company pays good dividends but its market price is very high, then the dividend yield is low and thus the fund may not invest in it. Apart from the dividend yield, the fund houses also look at growth prospects and other fundamentals before investing.

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Dividend option vs dividend yield fund

Investors often get confused between a dividend yield fund and the dividend option of a mutual fund. Most mutual funds offer a growth option where the value of the investor’s holdings increases when the fund makes profits by selling its holdings, and a dividend option wherein the investor receives these profits as regular dividend payouts from the mutual fund. A dividend yield fund targets specific shares and investments and as dividend payout from the companies as its core theme. It is also available in growth and dividend options.

Before investing in dividend yield funds, investors should look at past performance of the fund, risk tolerance, tenure of the fund, size of the corpus, etc. Investors who are conservative and prefer dividend yield should look for funds that have a higher allocation to large cap stocks. Also look at the period for which the fund has been in existence. A fund that has seen multiple market cycles is in a better position to offer stable returns as compared to the relatively new one.

For whom is it suitable?

Dividend yield equity funds are not recommended for investors who are looking for stable returns with low volatility. While the funds invest in financially sound companies with an excellent track record, the returns may not be stable and can fluctuate according to the market cycles. Those with a high-risk appetite should also avoid these funds as these will not generate high returns based on capital appreciation. This type of fund is recommended for investors who wish to invest in equity but are not very comfortable with the market’s high volatility.

What makes dividend yield funds preferable to dividend-yielding stocks is that such funds provide the benefit of diversification of the portfolio, which directly reduces the risk of investment. As the equity market witnesses a high level of volatility, limited exposure to dividend yield mutual funds is recommended for every investor aiming to build a diversified portfolio.

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STABLE RETURNS

* A dividend yield fund that has seen multiple market cycles is in a better position to offer stable returns

* It targets specific shares and investments and as dividend payout from the companies as its core theme

The writer is a professor of finance & accounting, IIM Tiruchirappalli