The Hindu Business Line : Fund Talk

I bought SBI Magnum Tax Gain Fund at a NAV of Rs 57 per unit. Last month, I received a dividend from this fund and the fund's NAV has now declined to Rs 42. I want to know if it is possible to get NAV appreciation in addition to dividends from an equity fund. Second, is the dividend, growth or dividend reinvestment option the best for an investor?

Parveen Gupta

To understand why the NAV of a fund falls after a dividend payout, you must remember that dividend payouts by mutual funds are quite different from those declared by companies. A dividend paid out by a company adds to the investors' returns because it is received in addition to any capital appreciation earned on the company's share. But in the case of a mutual fund, a dividend comes out of the price appreciation earned by the fund. It does not add to the overall returns for an investor.

An equity fund generates returns when the stocks in its portfolio register a price appreciation over a period of time. The fund may choose to distribute these gains by way of dividend payouts or it may choose to retain the profits, in which case the investor earns returns by way of appreciation in the fund's NAV. Since the dividend payout for a fund comes out of its NAV, the NAV will fall to the extent of the dividends paid per unit, after each such payout.

Investors should thus note that when choosing between Dividend and Growth, they are merely making a choice between different vehicles to earn their returns. When evaluating a fund's performance, it is the total returns, after considering both dividends paid out and NAV growth, that are relevant to the investor.

Yes, a fund may generate NAV appreciation over and above the dividends it pays out. Once a fund registers an appreciation in the value of its portfolio, it may distribute a part of this appreciation to investors by way of dividends, the rest of the appreciation will be reflected in the NAV. Usually, dividends are paid out of the profits actually realised by the fund manager by selling the stocks in the portfolio. Whether a fund declares a dividend or not, the investor is still entitled to the returns generated by the fund over his holding period. In an open-end fund, you can choose to redeem your units in a fund to realise profits, even if the fund fails to declare a dividend.

The choice between the dividend and growth option should be based on your investment horizon, tax status and risk profile. Dividends declared by equity funds under Dividend options are tax-free in the hands of the investor. But returns earned by way of appreciation in the NAV on the Growth option are taxed as capital gains. If you hold units for less than a year, this appreciation may be taxed as short-term capital gains at the rate of 10 per cent. If you hold for over a year, the returns are treated as long-term gains and are exempt from capital gains tax at present.

Therefore, if your horizon is less than a year, the Dividend option is the more tax-efficient way to earn returns. In addition, the choice between dividend and growth should also depend on your ability to handle ups and downs in the value of your investments. If you are an investor who likes to periodically book profits on your equity investments and re-balance your portfolio, the Dividend option is best suited to you. If you have the ability to stay invested through volatile phases and are targeting higher returns over the long term, the Growth option would suit you better.

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Aarati Krishnan

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