Is it unusual that two of India’s top five equity-oriented funds are balanced funds? HDFC Prudence Fund (HPF) is India’s largest equity-oriented fund with assets under management (AUM) of Rs31,717 crore, as of September 2017. ICICI Prudential Balanced Fund (IPBF) packs an AUM of Rs19,601 crore. The question we ask is: are investors smart to choose a lower-risk route to equity exposure through a balanced fund, or is there some other story playing out?
If the reason is that investors made a smart choice, then balanced funds of all fund houses would be among the largest. But only six of the 40 fund houses have their balanced funds larger than their other equity funds. Could it be that the performance of these two balanced funds is so much better than the category average, that investors are choosing performance? However, HPF and IPBF have given satisfactory returns, not stellar performances. Balanced funds of L&T Asset Management Co. (AMC) Ltd and HDFC Asset Management Co. Ltd’s other balanced fund have done just as well and even better at times than these two largest balanced funds over the past 5 years; IPBF didn’t even finish 2017 in the top quintile.
So, what else could be at play? Look at the way some fund houses are using large regular dividend payouts to attract investors. We need to look at the corpus of dividend plans. Mutual funds offer two options to investors: growth and dividend. In a divided plan, the capital gains are paid out periodically to investors by declaring a dividend. These plans are good for the retired and those targeting regular income. They are not good for those who want to build a long-term corpus.
The size of HPF’s dividend plan was Rs17,917 crore, almost twice the size of its growth plan (Rs9,810 crore). Sundaram Balanced Fund, one of the smaller funds in this category, too has a dividend plan (Rs305 crore) that’s bigger than its growth plan (Rs281 crore). A look at the largest balanced funds tell us that not all funds have disproportionate inflows in the dividend plans of their balanced funds. Fund houses like SBI Funds Management Co. Ltd and L&T AMC have seen almost similar rise in the corpuses of their respective balanced funds’ dividend and growth plans between January 2016 and September 2017. HPF’s dividend plan, meanwhile, went up 192% as opposed to its growth plan that went up just 43%. IPBF’s corpus went up 365% (monthly dividend plan), as opposed to its growth plan that went up 132% (see graphic).
What’s wrong with declaring dividends? Nothing, but when investors are verbally promised a regular monthly dividend in a non-guaranteed product, it stinks of mis-selling. “In the past 1 year or so, equity markets have gone only one way—up. Many investors who’ve come into equity funds or balanced funds in the last year or so haven’t really seen a major correction. The dividends may look attractive, but if markets start to fall, dividends could be in jeopardy. What then?" said Amol Joshi, founder, PlanRupee Investment Services.
But rising equity markets aren’t the only reason why investors poured money into balanced funds—Rs95,959 crore in 2017, up from Rs37,705 crore in 2016. Many balanced funds held out a carrot for investors; a regular and monthly dividend. And distributors, especially banks, were only too happy to oblige. Data from Computer Age Management Services (Cams Ltd; one of Indian mutual fund industry’s largest registrar and transfer agents) reveals that many distributors, particularly banks, sold more of dividend plans than growth plans of balanced funds in the past 2 years. For private sector and foreign banks (part of ‘other banks’), 63% of their overall balanced funds sale was in dividend plans, in financial year 2017, as well as in the April-November 2017 period, and 51% for independent financial advisers. (Cams’ data is till November 2017 and covers only those funds that it services; the AUM of these amount to 64% of the mutual funds industry.)
There is nothing new about balanced funds paying dividends. Data from Accord Fintech tells us that HPF has regularly paid a dividend of 11-15% (dividend yield) between 2005 and 2015, typically once a year. The average dividend yield of IPBF in the same period was around 4%, and increasing towards later years. The big change is that many balanced funds, including HPF and IPBF, have now switched to paying dividends monthly from a payout once a year. From January 2016 till date, HPF has paid dividend in all months. Additionally, many dynamic asset allocation or balanced advantage funds (those that invest in arbitrage opportunities, equities and debt) have also been paying dividends monthly, as opposed to once a year before. Dividend yield is dividend per unit (in rupees) divided by its prevailing net asset value. The question is: do fund houses market dividend plans on the back of their own dividend track record? Or do they sell funds based on whether or not they’re appropriate for their investors?
HDFC Asset Management Co. Ltd did not respond to our queries. Raghav Iyengar, executive vice-president and head-retail and institutional business, ICICI Prudential AMC, said: “We have been always advocating investors to refrain from investing based solely on past performance. There are several other criterions to be taken into consideration while making an investment decision. A fund’s track record can be considered only to understand how the fund has behaved across varying market conditions, such that an investor has the confidence to invest in a fund."
Are distributors selling the funds right? We sent questionnaires to some of India’s largest distributors, HDFC Bank (HDFC AMC’s largest distributor in financial year 2016-17 based on commissions, as per Prime MF database), ICICI Bank, Citibank, ICICI Securities, NJ India Invest Ltd and Prudent Corporate Advisory Services Ltd. We asked them three questions broadly:
1. If they sold balanced funds?
2. What did they sell more in 2016 and 2017; dividend or growth plans of balanced funds?
3. If they ensured product suitability when selling dividend plans of balanced funds to their investors?
Mint did not receive any response from these distributors. Selling ‘unsuitable’ products violates the Fraudulent and Unfair Trade Practices regulations of the Securities and Exchange Board of India.
The fall in interest rates on traditional fixed-income instruments also made balanced funds look attractive. “If the fund returns around 15% a year, it can afford to pay 9-11% dividends a year," said the chief of a fund house who did not wish to be named. None of the fund executives whom Mint spoke to, agreed to come on record for this story.
Internationally, too, it’s common for investors to seek mutual funds for a regular dividend income. Jeffrey Ptak, head-manager research, Morningstar Inc., said, “Investors look at mutual funds for regular income, be they bond funds or income-oriented stock funds. Dividend-oriented funds are popular among investors for this reason. We see them used commonly in the US and elsewhere."
While seeking dividends from income funds can be explained, declaring monthly dividends in equity funds does raise questions. For instance: can balanced funds sustain dividends? Sebi rules mandate that mutual funds can only declare dividends out of realised gains. Here’s where large and established balanced funds have an edge. An older balanced fund that would have booked profits in its career, wouldn’t have distributed everything. These booked profits go into a special fund. “This helps a balanced fund maintain continuity in paying dividends even if markets turn negative and profits are hard to come by momentarily," said anther fund house’s chief, citing it as the key to paying “regular dividends" with older funds like HPF.
But G. Pradeepkumar, chief executive officer, Union Asset Management Co. Pvt. Ltd, said that some fund houses also tacitly take investors’ permission to redeem their units (through systematic withdrawal plan) to be able to maintain a consistent dividend rate. Mint could not independently verify this claim.
Mutual funds, and particularly balanced funds, became more attractive post-demonetisation. A surge in deposits led to banks reducing interest rates on term deposits. Investors switched to mutual funds looking for a regular income. And balanced funds that offered the prospects of monthly dividends offered solace.
Although many balanced funds have been paying dividends regularly in the past 2 years, there is no guarantee that they would continue to do so. “To set an expectation of 8-9% dividend yield per year is dangerous. It is possible that your balanced fund can give an average return of 12% over, say, 10 years, but if in some years it can give you 25-30%, in some years it could fall by 15-20%. To expect equity-oriented funds to give regular dividends, therefore, is foolhardy," said Shyam Sunder, managing director, PeakAlpha Investment Services Pvt. Ltd.
Joshi suggests that if you want some regular income from your equity-oriented fund, systematic withdrawal plan works better. “This way, you can decide how much you want to withdraw," he said. While smart investors will do the right thing, the worry is that many first-time equity investors are being mis-sold the dividend plans and they will lose faith when the dividends dry up. Markets go up and down, and when the next downturn comes, we will have an army of investors crying foul.