Companies that pay consistent dividends are usually considered to be mature businesses with strong cash flows and hence their stocks are less volatile. But lower volatility does not mean stock returns will be staid. Dividend-yield funds i.e. thematic equity schemes that predominantly invest in dividend-yielding stocks, as category in the past one and three-year periods have beaten both bluechip index Sensex and large-cap funds by a good margin. With downside capture of these products remaining low, dividend-yield funds can be a good choice for investors in volatile markets.

Decoding strategy

Dividend yield is a financial ratio that shows how much a company pays out in dividends each year relative to its stock price. High dividend-yielding stocks represent good cash flow in business and management commitment towards shareholders. During periods of volatility, high dividend-paying stocks become a safe haven. Dividend-yield funds invest at least 65 per cent of the portfolio in dividend-yielding stocks. There are eight funds in this category, with seven having at least one-year track record.

While the criterion of dividend yield is used to identify the investment universe from which the portfolio is constructed, within this universe, many funds have strong focus in selecting companies that have good corporate governance, strong fundamentals and growth prospects. A few funds also have exposure to overseas stocks, but limited in scope. Across dividend-yield funds, preferred stock picks hail from IT, pharmaceuticals, metals, energy and consumer sectors. Financials, materials, chemicals and automobiles have found place in some portfolios. 

The schemes usually invest across market capitalisations (multi-cap), with bias towards large-cap stocks (48-76 per cent). Some, such as ICICI Pru Dividend Yield Equity, follow a blended (growth and value) investment style, while others like UTI Dividend Yield stick to value strategy.

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Weathering storms

Given the nature of high dividend-yield stocks, dividend yields do not compromise on downside protection. The downside capture ratio, based three-year monthly numbers, shows that the portfolio of these funds on an average fell only 84 per cent compared to the index during down markets; this is a reason the funds have outperformed broader markets. Templeton India Equity Income and UTI Dividend Yield have clocked the best downside capture ratios.

We also looked at periods of excessive declines over the last 10 years. The Sensex witnessed seven instances of at least 5 per cent drop in a month in the last decade. These include the 23 per cent drop in March 2020, the 7.5 per cent crash in February 2016 and over 5 per cent correction in February 2013. A majority of the dividend-yield funds protected investor wealth during such phases, with UTI Dividend Yield and Templeton India Equity Income figuring regularly among the top performers.

Standard deviation (SD) measures volatility of past mutual fund returns. Greater standard deviation indicates higher volatility. Based three-year monthly numbers, dividend yield funds' SD category average is 5.3 compared to 5.8 for multicap funds, 5.9 for largecap funds, 6 for value-focussed funds and 6.4 for large and mid-cap funds. So, clearly, based on available data, dividend-yield funds are less volatile and hence investors can expect their returns to deviate less from the expected returns based on past performance.

How returns stack up

Stock markets in the past one month, starting with when Russia attacked Ukraine, have shown classical volatility. After swinging on both sides, the Sensex is up 0.64 per cent in this period. But dividend-yield funds, as a category, are up 2.6 per cent in the same time.

Looking at longer time periods such as one year and three years, dividend-yield funds have done well. This fund category has given 26 per cent and 18 per cent returns in one and three-year period vis-a-vis the Sensex which is up about 15 per cent for both and large-cap funds (17 per cent in one year and 15 per cent in three years). Do note, dividend-yield funds category average returns in five and 10-year periods converge with large-cap and in general, the broader thematic categories at 13-14 per cent.

In terms of alpha i.e. excess return over benchmark, 85 per cent of dividend-yield funds score better in one-year period, 80 per cent in three-year period, 60 per cent in five-year period and 75 per cent in 10-year period. We found Templeton India Equity Income and UTI Dividend Yield most consistently beating Nifty Dividend Opportunities 50 across time-periods. Considering their outperformance on other parameters (as discussed above) too, investors can consider them for investments.