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MF dividends: Appearances can be deceptive

| 12/5/2011 11:05 AM Monday

Although performance is an important criterion for deciding whether a fund is good or bad, it is critical to measure it in a manner that reflects the true picture. Many investors consider only dividend to measure a fund's performance. A lower dividend or a delay in  declaring dividend, even in a subdued market, often causes disillusionment in their minds. However, it is important for investors to  remember that mutual funds can pay dividends only out of the booked profits. Hence, a falling market can compel a fund to either pay a lower dividend, or delay announcing the dividend.

Investors need to know that they would lose out in the long run if a fund declares higher dividend in a market situation like the current one. Remember, the right way to measure the performance of a fund is by considering the ‘total return’. Total return is the sum of two  components − dividend and capital appreciation. For mutual fund investors, these elements provide the ‘big picture’ of what their investments are doing for them.

Another situation that often causes dilemma in the minds of investors is when a successful fund manager leaves the fund. This is  generally a very tricky position. While this would be likely to ring alarm bells, it may not always be wise to react immediately by  redeeming the holdings from the fund.

For example, if one is invested in an index fund, a dividend yield fund or a fund wherein the rules regarding what the fund manager can do are clearly on its performance. It is also important to look into the management style of the fund house, especially how much independence is given to the fund manager. Most big fund houses usually have guidelines that a fund manager must conform to. In fact, in some fund houses, the process of investments is overseen by an investment committee. Therefore, a fund house following  such an approach may not find it difficult to replace a good manager with another one. Besides, if the fund has been in existence for a relatively shorter period, a change in the fund manager may not make much of a difference.

Even if it becomes clear that the former fund manger enjoyed considerable independence, a decision to sell off the holdings should not be taken without finding out as much as possible about the new fund manager. If he/she ran a different fund, check the fund’s track record. Ideally, a new fund manager should be given at least six months or so to prove himself/herself spelled out, any change in the fund herself. If at the end of that period, the fund has performed poorly compared to its peers, it may be time to act.

Another important point to consider is the volatility of the returns provided by the fund. A volatile fund is often a cause of worry for  investors. Hence, it is important to match one’s risk tolerance with the expected level of volatility of the fund.

In sum, it pays to look carefully when you face special situations, rather than to jump the gun first and have to ask the fund house to return the money later.

 

Find More Articles on: DSIJ Magazine, In Focus, Personal Finance, Mutual Funds

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