July 17, 2018

Junk dividend plan options in mutual funds

Image result for dividend planMutual funds are not corporations to have any earnings of their own; they are basically portfolios of corporations which generate “returns”, not “earnings”. Further, corporations rarely find themselves in a position to return capital or meet cashflow requirements of investors, whereas mutual funds can provide liquidity to their investors almost at call by way of resale of units.

So why such take up of dividends by mutual fund investors despite unreliability and no fundamental reason? It’s not like all investors go for dividend options; in fact around 50% of all investors and probably a larger value of assets under management (AUM) is probably in growth plans as dividends have become less tax-efficient over time. Interactions with investors tell us that there is a good base of investors who want cashflows but are unable to differentiate between terms like return on capital, return of capital, dividends and plain cashflow requirement. Dividends connote “return on capital” without a direct proportionate impact on the original capital and this is what draws investors to dividend; whereas applied to mutual funds, the concept almost entirely results in “return of capital”. One can argue that mutual funds too earn dividends from underlying companies but a simple calculation of dividend yield on some of these portfolios will tell you the argument is bogus. Corporations usually declare dividends after audited profits for a review period are announced and the management, after factoring capital related decisions, recommends a payout to the board. Dividend declarations from mutual funds are indeed “return of capital” as gains generated by mutual funds are only from the sale of securities and there is no correlation between the act of declaring dividends and trading operations of funds.

A portion of investors has capital that they can invest, but it is from this capital that they need to sustain themselves, which requires predictable cashflow. Yet another set of investors does not want cashflow for sustenance but sees regular cashflow as frequent “profit-booking” from a variable return asset or they see cashflow from

Read more at https://www.livemint.com/Opinion/zHn00TKQ7dyXw3yEfA264O/Anyone-in-the-mood-for-dividends.html

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