Don't be surprised if your monthly dividend for February 2018 is lower than what you have become accustomed to over the previous few months
We have been cautioning investors about this for a while now. Hybrid funds— which have a mix of equity and debt securities, and are often mis-sold by some distributors and fund houses in the garb of regular monthly income-giving instruments—are now under pressure due to volatile markets. The BSE Sensex has barely seen any gains since the start of this year. It has returned 0.07% from January 2018 till date. For the same period, the balanced funds category has shown as average return of -2%.
In recent months, the average 1-year return for hybrid funds with 20-25% allocation to equity has gone down to around 8.5% (February 2018) as compared to around 15% a year ago. For balanced funds with around 65-70% allocation in equity, the average 1-year returns are now in the range of 13-14% as compared to 23-25% a year ago.
Add to that the 10% dividend distribution tax introduced in the Budget 2018. The post-tax dividend return from these schemes will look even lower.
Falling returns and regular income
Don’t be surprised if your monthly dividend for February 2018 is lower than what you have become accustomed to over the previous few months.
This kind of falling return trend, if it continues, can potentially impact the quantum of monthly dividend that funds are able to pay out. In some monthly income plans, monthly dividend payouts have almost halved in February compared to the previous month. It’s not without precedent though. In the past, too, these schemes have missed dividends during prolonged or sharp corrections in equities.
But not all funds have paid lower monthly dividends as yet, given that there are accumulated profits which can be used as a buffer. Continued downtrend in equities may, however, change this.
There are two ways in which you can earn regular income from a fund, either via regular dividends or by systematic withdrawals at regular frequency. You can invest in the growth option, which keeps the gains in the fund itself resulting in the value of your units growing; and separately structure systematic withdrawals for the amount and frequency you need.
Unlike the dividend pay-out which is controlled by the scheme, systematic withdrawal can be defined by you. But in both cases, your investment suffers if the equity markets begin to correct.
In case of the latter, if you have invested, say, in the last 1 year, the systematic withdrawal of a defined amount is likely to eat into the original capital if equity market correction continues.
Let’s say your hybrid fund has 80% in fixed income accrual securities and 20% in equity; the fixed income portfolio has a yield of 8% per annum and the equity portfolio for the month is up 1%. Your portfolio return for the month will be around 0.73%. Now let’s say, in the next month the equity portfolio returns fall by around 1%. In that case, your return for the month falls to 0.33%. This not only lowers the amount available for dividends, it also means that if you continue to withdraw the same amount as earlier, incrementally you may be taking away more than what is getting added. Eventually, this will shrink your total investment value. Given the potential of sharp changes in equity value, short-term returns in hybrid funds can be severely impacted, and this makes them unsuitable for reliable regular income.
While an upward change in equity value will see more getting added to your investment, a downward change will take away from your investment value.
Some funds are able to manage continued dividend pay-out in short-term equity corrections, but these too may get affected if the equity correction is prolonged.
Pure debt funds that rely majorly on accrual-based income are best suited for those looking for regular income, since volatility in such schemes is low and so regular income is more consistent.
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