The Hindu Business Line : Dividend or growth, that’s the question

Coimbatore, Aug. 31 Dividend or growth plan – is the dilemma the mutual fund investors face while choosing the investment plan. The continuous volatility the market has been witnessing since January that has seen steep erosion in the value of stocks as well as mutual fund units has lent this added importance.

The long bull-run the market had witnessed till January this year saw the value (NAV) of mutual fund units rising to levels not seen earlier and some of the funds’ growth option NAVs rivalled blue chip shares in value! This value appreciation also helped the funds dole out liberal dividends, which in some of the funds like Principal Tax Savings Fund was at an annualised 58.87 per cent for the past five years as on December 31, 2007.

Normally, the dividend option is chosen by those who would like to retain their investments in the mutual funds even while expecting periodic returns from it without actually redeeming any investment. In the growth option, to realise the growth in value or to meet financial needs, investors had to redeem the units. In the growth option, the earning is ploughed back into the scheme itself which is reflected in the NAV and as in the case of cumulative option in bank deposits, witnesses an exponential value growth over a period of time.

Both the options have their own advantages. Both are equally tax-neutral in that with the abolition of long term capital gains tax. For those opting for dividend option, the dividend declared by mutual funds would be tax free at the hands of the unit-holders.

Changed scenario

But the nearly 30 per cent fall of the Sensex from the high of 21000+ points in January has had a sobering impact on share prices and on NAVs mutual fund units, raising questions as to whether the funds would persist with their hefty payouts. Some of the old funds have still schemes with good NAVs under the dividend option but in a bear market any profit booking would fetch far lesser value than in earlier years.

A look at the dividend history of some of the funds would help put the issue in proper perspective. The Reliance Mutual Fund has made screaming headlines that the Reliance Growth and Reliance Vision Funds have declared 100 per cent dividend (Rs 10 per unit) a year for five years in a row and claimed that as per ICRA Online data, these were the ‘only two funds in India to have such a track record’. In fact during 2003-04, both the funds gave a pay-out of Rs 19.50 per unit! However, the market meltdown has not spared them and in the six months ending on June 30, 2008, while the growth plan of Reliance Growth Fund saw a change in NAV of negative 35.03 per cent, in the case of Reliance Vision Fund (growth option), it was negative 39.72 per cent. Naturally, this keeps the investors guessing as to whether it would be encore in case of dividend payment this year or whether the fund would prune the payout.

HDFC Mutual Fund’s dividend payouts were more modest but still they were good. The HDFC Equity Fund had paid a dividend of Rs 5 an unit in 2005-06 and 2006-07 and upped it to Rs 5.50/unit last year. While HDFC Top 200 Fund had paid Rs 5/unit as dividend in the past two years, HDFC Prudence Fund has maintained this payment record for the past four years. But in the six months ending July 31, 2008, all these funds have shown negative returns.

This brings the question as to whether investors should opt for growth option or dividend option in a mutual fund. Mr Hitungshu Debnath, Executive Director-Distribution and Wealth Management Services, Angel Broking, Mumbai, feels that while those who invest from a capital appreciation point of view over long term should choose the growth option, those seeking regular income should pitch for the dividend option. But investors should understand that the dividend payment is not assured and if there were no surpluses, there would be no dividend.

On which option is the most tax efficient, he says that returns(capital gains) from equity MFs held for more than a year were tax free but those redeemed before one year would be taxed at 10 per cent. His advice to investors worried about market meltdown was to stay invested with a long term investment horizon.

Mr K. Venkitesh, National Head, Distribution, Geojit Financial Services, Mumbai, said mutual funds reflected the trend of the equity markets and hence, “we are clearly into tougher times”. On whether the funds would generate high dividend yields, he expected the quantum of dividend to come down more than 50 per cent from last year.

Mr Debnath, on how he expected the MFs to perform in the current fiscal, said factors such as high valuations, inflation, oil prices, political uncertainties and interest rates have had an impact on the correction seen so far and high inflation and interest rates continue to weigh on the markets. Markets reflect the growth in the economy and “mutual fund returns should be able to reflect the same based on prudent fund management”.

MrVenkitesh asked whether balanced fund would be a better option because of the debt component making them less volatile, said “to some extent yes but not to a great extent”.

So where does this lead the investor? The ideal solution would be to stay invested in a fund through different market cycles and add to the size of the holdings because of the benefit of cost averaging. The higher unit holdings would compensate to some extent for the lower dividend payouts and both the options address specific needs of investors and one is not superior to the other. When the market recovers, the jump would be swift, leaving little time to the investors to react.

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