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Stock selection based on dividend yield has proved a good strategy for Indian investors to beat market returns over the long term. It has worked particularly well in the choppy markets of the past three years. The new IIFL Dividend Opportunities Index Fund plays on this theme.
The portfolio
The fund is an open end but passive fund that plans to mirror the returns of the CNX Dividend Opportunities Index. It will invest a minimum of 95 per cent of its portfolio in this index, with the rest parked in debt/money market instruments.
Returns from the CNX Dividend Opportunities Index have averaged 17 per cent on a compounded annual basis in the last three years, while the Nifty managed just 4 per cent.
The ongoing slowdown in corporate earnings and rising interest rates that have hurt highly leveraged companies, have enhanced investor preference for cash-rich companies. That has helped dividend yield stocks outperform.
This index, maintained by India Index Services and Products Ltd, invests in fifty highest dividend yielding companies at any given time.
These companies are selected from a universe of top 300 stocks by free float market capitalisation, filtered for positive net worth, profits and turnover.
The free float and turnover criteria make sure that the selected stocks are liquid. Individual exposures are capped at 8 per cent.
The index currently has stocks from 25 different sectors, the top ones being banks (19 per cent), auto (12 per cent), cigarettes (9 per cent) and oil (9 per cent).
What we like
The fund's passive strategy may deliver benefits to investors on two counts. One, it will help follow a dividend yield strategy without the portfolio choices being influenced by biases or sector preferences of the fund manager. While there are a few active funds in India that follow dividend yield investing — Birla Dividend Yield Fund, Tata Dividend Yield , UTI Dividend Yield Fund, to name a few — these funds have seen some returns divergence.
Their three-year returns have ranged between 13 and 18 per cent, with just 2 funds beating the CNX Dividend Opportunities index. Being a passive fund, IIFL's Dividend Opportunities Index Fund may ensure index-linked returns.
Two, India Infoline being a relatively new entrant to the Indian mutual fund industry lacks a track record in managing equity funds.
Until it establishes a track record in active funds, passive funds may be the preferred choice for investors betting on this fund house.
Low costs are also an added advantage with passive investing. Compared with the annual expenses of 2.5 per cent charged by actively managed equity funds, IIFL plans to levy an annual expense ratio of 1.5 per cent on this fund.
This can make a significant difference to long-term returns.
What we don't
Investors should note that this fund is an open end index fund and not an exchange traded fund. This may result in a higher tracking error relative to the index.
Open end index funds in the Indian context have generally tended to have high tracking errors because of the need to maintain a higher cash balance to meet redemption/dividend obligations.
Frequent index changes could also lead to higher transaction costs and tracking error.
IIFL expects to limit the tracking error on this fund to 2 per cent (this is rather high) but mentions that tracking error could exceed this limit under exceptional circumstances.
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