Do Index Funds and Exchange Traded Funds pay dividends?
Before we get into the details, you should know about Benchmark and Total Returns Index.
What is a Benchmark?
A benchmark is a group of securities which are considered as a 'benchmark' to measure a fund's performance. Benchmarks are generally broad market indices like BSE Sensex 30, NSE Nifty 50, with which mutual fund returns are compared with.
In case of index funds or ETFs, say a Nifty 50 Index Fund, the Index Fund is expected to give the returns of Nifty 50 index's performance less the expenses incurred by the fund.
For e.g, If Nifty 50 returns 10% per year, the Nifty 50 Index Fund is expected give the same returns of 10%.
Total Returns Index.
The Nifty 50 index has India's top 50 companies and every year these companies declare dividends.
Nifty Total Returns Index, is nothing but Nifty plus the total dividends announced by Nifty companies, which are assumed to be reinvested. Every year the about 1.5-2%,which is the dividend yield of Nifty 50, is added to Nifty 50.
So, currently Nifty 50, the price index, is at 11,000 whereas the Nifty 50 Total Returns Index is at 15,700.
Prior to 2018, all the funds were benchmarked against price index, Nifty 50 in our case. But SEBI circular made all the funds to be benchmarked against Total Returns Index.(Nifty 50 TRI).
Image: Returns of HDFC Nifty 50 Fund vs Nifty 50 TRI. The difference is due to the expense ratio and tracking error.
What happens to dividends declared by these companies in Index funds?
The dividends from Index companies are reinvested back in Index Funds/ETFs. This will reflect in increase of NAV and it will replicate the returns of Total Returns Index.
Note:
Until 2018, Index funds and ETFs like Nifty Bees, SBI Nifty 50 ETF gave out dividends.
After 2018, the dividends are NOT given out, so that the index fund returns reflect exactly the same returns of Nifty 50 TRI.
So, if you check the returns of index funds or ETFs compare them with Total Returns variant of the benchmark index, like Nifty 50 TRI or Nifty Next 50 TRI or Bank Nifty TRI.
Know more about Total Returns Index.
Any views or comments, do post in the comments section.