Dividend-yield mutual funds have outperformed their flexi-cap cousins, a longtime favourite of investors, over the past 3, 5, and 10 years. Should you include them in your portfolio?
Such funds invest primarily in stocks of companies that pay a dividend (a portion of their profits) to shareholders. Dividend yield is simply the dividend amount relative to the company’s share price. They work like a dividend-yielding version of flexi cap funds, which also have the freedom to invest across large, medium and small-caps in any proportion. However, many dividend-yield funds currently have big allocations to large-caps that pay sizeable and sustainable dividends.
According to Value Research data, dividend-yield funds returned an average of 19.22% and around 18%, and 16.5% annually over the past three, five and 10 years (as of 18 February), while flexi-cap funds returned 16.85% and 14%, and 14.75% on average over the same periods. A recent rally in stocks has narrowed the average one-year returns to about 14% for both categories.
Financial advisers said a run-up in dividend-yielding stocks in 2025 has helped lift the overall returns of the category for the 3-, 5-, and 10-year periods. However, this is not an indication of long-lasting outperformance. “I would not read too much into this,” said Suresh Sadagopan. founder and managing director of Ladder7 Wealth Planners, a Mumbai-based fee-only investment adviser registered with the Securities and Exchange Board of India (Sebi).
He said investors should look at other factors besides performance when deciding if a fund is suitable for them.
Stability in a storm
Financial advisers said dividend-yield funds can do better in certain conditions, such as when there is a lull in the stock market, as in a large part of 2025. In such a situation, dividends provide a nearly assured return, and when markets are volatile, the stock prices of such companies typically fluctuate less than those that don’t pay dividends.
When the covid-19 pandemic struck in 2020, the broad market Nifty 50 Index fell nearly 34% between 13 February and 3 April, while the Nifty Dividend Opportunities 50 Index, which holds only dividend-yielding companies, fell only 26%.
“The stability is higher,” said Sadagopan.
Pankaj Mathpal, founder of Optima Money, a Mumbai-based mutual fund distributor, said, “Investors who want less downside risk can consider these funds.”
However, when the stock market is rising rapidly, dividend-yield funds tend to lag. “The appreciation in these companies will be limited as compared to other companies, which have a very strong growth trajectory,” said Sadagopan.
This was also evident back in 2020, when the Nifty 50 rallied 73% from 3 April to the end of the year, while the Nifty Dividend Opportunities 50 Index rose only 52.5%. Note that actively managed dividend-yielding mutual funds may perform differently as they may own different dividend-yielding stocks than the index.
How dividend-yield funds work
Dividend-yield funds are among the smaller thematic equity categories, comprising 11 funds with total net assets under management of around ₹32,450 crore as of 31 January, according to the Association of Mutual Funds in India. There are also two exchange-traded funds (ETFs) that track dividend indices. For comparison, flexi cap, the largest category of equity funds, has 44 funds with total assets of around ₹ 5.47 trillion.
Like flexi-cap funds, dividend-yield funds are not comparable to each other, because each fund may have a different allocation to large-, mid- or small-cap stocks. Investors who wish to buy a dividend-yield fund, therefore, need to analyse the underlying assets to decide if it makes sense for them.
These funds also use slightly different strategies to select which dividend-paying companies to invest in. Amit Premchandani, fund manager at UTI Dividend Yield fund, looks for high-dividend-yield stocks with growth potential, but avoids the top 20% most volatile stocks of the Nifty 500 Index to reduce risk. The regular version of the fund (bought through a distributor) is up around 13.3% over the past year (as of 17 February).
In 2025, the fund increased its exposure to consumer durable companies and carmakers, as well as companies that have lower dividend yields, like banks and healthcare companies, but which he believes have good growth potential, Premchandani said.
Meanwhile, at ICICI Prudential Dividend Yield Equity fund, which has been among the top-performing funds in this category over the past year with a gain of 16%, the focus is on buying companies that pay dividends consistently, even if they don’t have the highest dividend yield. “Rather than looking at one past dividend, we also see if this is sustainable in future, and if it can grow,” said fund manager Mittul Kalawadia, who switches between market caps at different times.
Just after the covid-19 pandemic, the fund had a large allocation to mid- and small-caps, but after they rallied sharply, Kalawadia cut their allocation by half. Since 2024, the fund has shifted decisively towards large-cap stocks, which currently account for 79% of the portfolio. Around 12% is in mid-caps and 9% in small-caps.
In the coming months and years, Kalawadia said he expects good cash flows for telecom, auto, utility, and power companies, and some in the pharma sector. He has also invested in a real estate investment trust, an entity that manages income-generating commercial assets and distributes its rental earnings to unit-holders as dividends. “When we want safety, we come here,” he said.
Dividend-yield vs flexi-cap funds
While both dividend-yield and flexi-cap funds can invest in stocks of large, medium and small companies in any proportion, Mathpal recommends dividend-yield funds to investors who are risk-averse as they tend to be less volatile.
However, since these funds are required to invest primarily in companies that pay dividends, they have a smaller universe of stocks from which to choose. There are more than 2,500 companies listed on the National Stock Exchange, but only a few hundred pay a dividend.
In fact, there are differing views on whether dividend-paying companies constitute good investments in the first place. Some experts, such as Mathpal, believe consistent dividend payments show that a company is genuinely making money and is cash-rich. Others, however, question the practice of paying dividends.
Sadagopan noted that when a company lacks productive uses for its operational cash, it may issue dividends to support the share price and reward investors. This is not inherently positive, as expansion requires investment, and internally generated cash is the most suitable source of capital. “Dividends are not always positive,” said Sadagopan. “There are pluses and minuses on both sides,” he said.
Unsurprisingly, he said he doesn’t invest any of his clients’ money in dividend-yielding funds. “We find that putting together a good portfolio with the basic large cap, mid cap and flexi cap allocation is good enough,” he said.
Choose the right version
Some investors believe that all dividend-yielding funds automatically pay dividends to fund holders, and are thus recommended for retirees who are seeking a regular income.
“That is a misconception,” said Mathpal. When buying the fund, investors can choose if they want regular dividend payouts by opting for the ‘income distribution cum capital withdrawal’ (IDCW) option. In this case, the fund holder will have to pay tax on the payout at their income tax rate. However, investors can choose the ‘growth’ option, in which case the fund will reinvest the dividends. This is true for all types of equity funds, not just dividend funds.
In summary, a dividend-focused fund may be suitable for investors who want equity exposure but with less risk. In return, they should be prepared to earn lower returns when the market is booming. However, a fund's performance should not be viewed in isolation, but rather in the context of a broader portfolio. Financial advisers point out that different asset classes excel under different market conditions, and that developing an asset allocation plan and sticking to it is better than chasing short-term performance. “We really should not change the strategy,” said Sadagopan.