BackDo closed-end funds pay promised dividends?
Mint Money did a study to check the frequency of dividends declared by closed-end MFs
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When the current breed of closed-end funds (let’s call them the new-age closed-end schemes) started to enter the market sometime around April 2013, they claimed to be different. They aimed to stand out on a couple of parameters. First, most of the closed-end funds launched in this period so far have said that they will return the money back to investors once the closed-end tenor (three years, five years, and so on) gets over. After the closed-end tenor gets over, these funds will not become open-ended. Earlier, many closed-end funds used to turn into open-ended schemes once the tenor got over. As a result, after a period of time a fund house used to end up with multiple schemes with very little difference among them.
Second, some closed-end funds said that they would aim to declare frequent dividends by regularly booking profits and pay them out to investors. Since many of these funds have completed nine months to a year, we decided to check their dividend declaration promise. Rising equity markets this year (S&P BSE Sensex has returned about 25% this calendar year) has made it possible for several equity funds to declare dividends.
But the question is: Did these closed-end funds declare more dividends- and more frequently- than the rest and have they stood out?
Our study shows that many closed-end funds have declared higher dividends than other equity schemes.
Closed-end funds declare more dividends
Among the top 10 equity schemes that have declared the highest amount of dividends—and more frequently—between January 2013 and now, eight schemes were the new-age, closed-end funds. In fact, three of these schemes had launched only dividend plans. Only one open-ended equity scheme, DWS Investment Opportunity Fund, figured in the top 10. The only other scheme that remained in this list, L&T Long Term Advantage Fund, was launched in March 2009. IDFC Equity Opportunity-Series 1 (IEO1) topped the list with the highest amount of- and most frequently paid- dividend declared and with the highest frequency. Ironically, IEO1 was the first of the new-age closed-end equity schemes to get launched.
In our study, we took only diversified equity schemes; large-cap, large- and mid-cap, multi-cap, mid- and small-cap schemes and tax-saving funds. We left out index and exchange-traded funds, Rajiv Gandhi Equity Savings Schemes, thematic and sectoral funds. We also omitted institutional and direct plans of all schemes across categories. And finally, we left out schemes that only had a growth plan and did not have a dividend plan, such as PPFAS Long Term Value Fund.
Of the schemes that remained, we took the growth in net asset values (NAVs) of their dividend plans between 1 January 2013 and now, for old and existing schemes. For those that were launched after 1 January 2013, we just took the difference in NAVs between their inception date and now. We repeated the same exercise for their growth plan NAVs. Lastly, we took the difference between the rise in their dividend and growth plans to ascertain who paid the most dividends, more frequently. Our study was not just about the quantum of dividends declared, but also to check how soon the scheme booked profits to pay off investors.
Is paying frequent dividends good?
Kalpen Parekh, chief executive officer, IDFC Asset Management Co. Ltd, claims that when his fund house saw where equity markets were last year, it saw a “thematic opportunity coming up at a point in time". Since equity markets were available at very cheap valuations, he says, it made sense to invest in “certain pockets of the market like well-managed and cash-generating companies and whose valuations were much lesser than those of large-sized companies". This opportunity or theme, adds Kalpen, was bound to play out for a finite period of time. “So if it is not going to play out forever, there’s no point of running such a fund forever. The key, then, is to book profits frequently and keep giving the money back to investors," he said.
This year, IEO1 paid three dividends—February, March and August. Other fund houses such as ICICI Prudential Asset Management Co. Ltd and Sundaram Asset Management Co. Ltd, who too have launched quite a few mid-cap funds in the past year-and-a-half, have also declared dividends regularly through 2014. For instance, Sundaram Select Micro Cap-Series IV was launched in March 2014 and paid out its first dividend on 30 May 2014, another dividend just 20 days after that and then a third dividend in August.
Not everyone likes the idea of giving out dividends, let alone as frequently as some of these closed-end schemes have been giving. “Every time a dividend is declared, the NAV falls. If a fund keeps declaring dividends, the investor would mostly spend it. Then at the end of three years when the closed-end fund matures and the investor gets her money back, she sees a lower NAV than what she might have anticipated. She wouldn’t know that the NAV drop was because of all the dividends she got over the years out of it, but she would just see a low NAV growth and tend to feel disappointed. You can’t go to an investor and tell her ‘I’ll give you small rewards every 2-3 months’. The objective of equity funds is to create wealth. Paying frequent dividends makes a mockery of it," said Kartik Jhaveri, founder and director, Transcend Consulting, a wealth planning firm.
“Reinvesting the money that investors get as dividends is also a big risk. The investor is again bothered about what to do with the dividend proceeds," says Hiren Dhakan, associate fund manager (portfolio management services), Bonanza Portfolio Ltd.
Parekh argues that a frequent dividend paying strategy is not meant for all investors. “These are thematic opportunities. It’s not meant for the first-time equity investor. It’s only meant for those who already have set portfolios and want to use this as a topping. For long-term wealth creation, like for those who want to invest for the next 10-20 years, who don’t want cash flows every year, there are different vehicles such as our buy-and-hold funds," he says. Parekh says that different strategies and funds are meant for different investors.
Jhaveri believes that wealth managers and financial planners wouldn’t like to suggest such a strategy for their investors.
What should you do?
It’s good that the new age closed-end funds aim to be different from their peers as well as those that were launched in earlier days. A frequent dividend paying strategy might sound good on the surface as it swears by frequent profit booking. And to be fair, most closed-end funds that were launched with such an objective have stuck to their word.
But the reinvestment risk remains a big one. It’s reasonably acceptable to invest for a definite period of just three years if you really like the strategy that your fund follows, but if it’s a big amount and you keep dividends regularly, what are you going to do with all those inflows? That’s the question you might find yourself asking way too often. We suggest you avoid opting for frequent dividends and stick to growth plans. Profit booking, we believe, is yours or your wealth manager’s choice.
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