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What is a Dividend?

Why the dividend from a company has a very different meaning than a dividend from a mutual fund

 A couple of weeks ago, I wrote about SEBI's tightening of the regulations regarding the payout of dividends in mutual funds. SEBI had ruled on March 15 that henceforth, funds would be able to pay dividends only out of accumulated returns and not out of money that is invested by unit-holders. As a result of this, some funds may not be able to pay dividends as liberally as they'd like to in order to attract investors.

However, is unlikely to make any dent at all in the basic problem-that of investors being attracted to funds because of dividends. Investors will continue to think the better of those funds that pay out higher dividends and funds will continue to pay out dividends in order to attract investors. Granted, such dividends will be paid out under SEBI's new accounting rule, but in terms of investors' understanding, that's neither here nor there.

In a curious way, in the matter of dividends, Indian investors are often guilty of evaluating stocks like mutual funds and mutual funds like stocks. In India, investors rarely pay any attention to the dividend yield of stocks, or even of a company's dividend track record as an indicator of it's attractiveness as an investment; which is something that they should be doing. Instead, they like to just look at its recent price performance and draw their conclusions from that.

On the other hand, dividends are a great seller of mutual funds, where they are not only irrelevant but-in a manner of speaking--non-existent. The very idea of comparing two funds' desirability on the basis of dividend should be a non-starter because the fund dividend is actually not a dividend at all. Instead, it is just a redemption of the returns that your money has already earned and that already belongs to you, whether you get it as a redemption or under the name of 'dividend'. Fund dividends are not dividend at all.

Corporate dividends are evidence that a company is generating distributable surplus. Fund dividends are nothing of the sort, in fact they are evidence of nothing at all. The only evidence of a fund's performance is it's NAV, and that's yours, regardless of anything.

The most interesting part of this widespread misunderstanding is the arithmetic of fund dividends. Let's say there's a fund whose NAV is Rs 30 and it declares a dividend of 10 per cent. That's 10 per cent of the face value of Rs 10 so the dividend is going to be Rs 1 per unit. The day the dividend is paid out, the NAV will drop to Rs 29 because dividend is taken straight out of the NAV. There's no financial difference at all between a situation where an investor has redeemed Rs 1 per unit and one where the fund company has paid out a Rs 1 per unit dividend. All that the fund company has done is to satisfy investors' irrational hankering after dividends and in the process made a marketing pitch to such investors.

However, there is a practical difference. As an investor redeeming your money, you control what you redeem yourself. When it's called dividend, the timing and size of the payout arises out of someone else's agenda.

Apart from the audience of knowledgeable investors of the sort who proactively try and understand this issue, I doubt there's any practical chance of people stopping this misunderstand. Except, perhaps, if SEBI renames fund dividends to something else, as it did with NFOs.