CONCEPTOF DIVIDEND IN MUTUAL FUNDS

I was recently looking at the dividend history of Birla Sun Life Advantage Fund and saw that they have announced the following dividends: 25 per cent in March 2004, 50 per cent in March and December 2005, 50 per cent in April 2008 and another 75 per cent in September 2009. If an investor puts Rs 1 lakh into the fund in 2004, would he have received Rs 25,000 in 2004, Rs 1,00,000 in 2005, and so on? What about the growth option? I would like to invest Rs 1 lakh in a mutual fund for dividends. Kindly suggest funds.
Vasantha Kumar.V

No, you have wrongly understood the concept of dividend payouts by funds. When any equity fund declares a dividend, the percentage dividend announced is usually calculated on the face value of each unit and not on its latest net asset value. Taking the above instance, a 50 per cent dividend on the Birla Advantage Fund would mean a dividend of Rs 5 per unit on its face value and not 50 per cent of its prevailing net asset value (NAV). Therefore, an investor in the fund would receive Rs 5 per unit and not 50 per cent of his investment value as dividend from the fund.
The NAV of Birla Advantage Fund's dividend option units was about Rs.46.7 per unit in early March 2004. Suppose an investor put Rs 1 lakh in the fund on March 1, he would have received about 2,142 units at the then prevailing NAV. Over the next five years, with the fund declaring a total dividend of 250 per cent, which is Rs 25 per unit, he would have received a total of about Rs 53,500 as dividend from the fund (number of units he held multiplied by Rs 25 per unit). That's a 53 per cent return.
Investors often make the mistake of putting money into equity funds based on their dividend announcements. However, such an approach is flawed for three reasons. One, the dividend announced is calculated on the face value of a fund. Remember when you invest in a fund whose NAV is at Rs 45 per unit, a ‘50 per cent' dividend will only fetch you Rs 5 per unit. That works out to a 11 per cent return on the fund's NAV.
Reflected in the NAV
Two, and more important, dividend declarations by a fund do not add to your returns as an investor. They come out of the fund's overall NAV. After all, how does an equity fund (or debt fund) make its returns? From an appreciation in the value of its portfolio. This appreciation is immediately reflected in the NAV of the fund.
Sometimes, when a fund's NAV shoots up, it ‘realises' this gain by selling some of its holdings and may decide to return that gain to investors in the form of dividends. That is why a dividend payout usually results in the NAV of the fund dipping to the extent of the payout, immediately after the dividend record date.
If you invest in a dividend option of a fund at an NAV of Rs 45 per unit just prior to a dividend of ‘50 per cent', you will find that you get Rs 5 per unit as dividends and the NAV of the fund falls to Rs 40 per unit after the payout. A dividend payout does not affect growth option investors of a fund, for them the realised gains will be retained in the portfolio and the NAV will remain at Rs 45 per unit, in the above example.
No guaranteed dividend
Three, though some equity funds declare a dividend every year, you cannot count on them to do so. A fund can only pay out a dividend if it is sitting on capital appreciation on its portfolio and has realised some of those portfolio gains. Equity funds, as all of us know, do not record positive returns every year. When the stock market falls, as it did in 2008, most equity funds register a depreciation in the value of their portfolio's value and will have no realised gains with which to pay out dividends.
As no one can guarantee that the stock market will rise predictably or steadily from year to year, one also cannot expect regular or annual dividend payouts from equity funds. This makes it risky for investors who seek regular income to look to the dividend option of an equity fund, for that requirement.
Subject to this, Birla Sun Life Frontline Equity, Franklin Prima Plus, HDFC Top 200 and DSP BlackRock Equity are some equity funds with a good return record that have also managed annual payouts of dividends in most years.
However, even these cannot pay out dividends like clockwork, as their performance too is contingent on market conditions. Only fixed deposits with safe entities or the post-office monthly income scheme can really guarantee the regular income that you are looking for!