Don't select mutual funds by dividend payout history

Choose the growth option because it will help create larger corpus due to compounding

Several equity mutual funds have recently announced dividend payouts. But should investors look at the dividend paying track record of a mutual fund before investing? No, say experts, because there is no real gain in the case of equity funds because the net asset value (NAV) will fall to that extent. In case of debt funds, investors will have to pay high dividend distribution tax (DDT), as much as 28.84 per cent.

According to the Value Research website, fund houses such as Birla Sunlife, BNP Paribas, ICICI Prudential, Canara Robeco, and IDFC are set to announce dividends shortly in their equity schemes. “Dividends are typically announced in bullish market when fund managers find it hard to deploy the money raised because they feel valuations are too high. They cannot keep money idle while waiting for more realistic valuations. So, they book profit and declare huge dividends,” says Tanwir Alam, founder and managing director, Fincart, a financial planning and advisory firm.

From a fund’s perspective, an equity fund’s strength lies in deploying the gains meaningfully in newer equity opportunities and not in just distributing them, points out Vidya Bala, head, mutual fund research, Fundsindia.com. That is why the dividend paying track record is not of much relevance, especially in equity funds, despite dividends not being taxed. “Equity funds are meant for long term. From an investor's perspective, equity funds are for building wealth and that cannot happen with dividend unless they redeploy the money to help compounding,” she says. That is why in equity funds, it is better to take the growth option. Similarly, in debt funds too, unless an investor is looking for some kind of regular payout or likes to keep exposure limited, one need not pay too much attention to dividend payouts.

“For investors, dividend is not a big gain because the payout is made from their own money. That is why after the dividend is announced, the net asset value (NAV) of the fund falls,” says Alam. It is only in case of arbitrage, income or liquid funds where the certainty of dividend makes sense.



“Dividend makes sense in case of arbitrage funds (treated as equity and therefore no DDT) and the recently seen equity savings funds (that use a combination of equity, debt and derivatives) where dividend is not taxed. Also, with sector funds, where investors have the risk of market timing, it may be a good idea to take some profits off the table occasionally,” Bala says.

Shankaran Naren, chief investment officer, ICICI Prudential Asset Management Company, feels dividends are a good way of returning profits to investors and hence, are attractive. “Equity is a volatile asset class. So, dividends are a good way of taking some profits and returning that to investors,” he says. Since the taxation is high in case of debt funds, if you are in the 10-20 per cent tax bracket, then it makes little sense to pay such a high DDT. “If you are looking for regular income, then it is better to use a systematic withdrawal plan (SWP), using the growth option. Over a three-year period, SWP is a better option as you can get capital gains indexation benefit,” Bala adds.