Why Don't Investors Like UK Income Funds?

Fund flows reveal that investors keep withdrawing funds from their income vehicles

Sunniva Kolostyak 14 November, 2022 | 9:08AM
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Investing in dividend stocks is very popular in the UK. Investing in UK income funds, though? Not so much.

Every month, we report on asset flows coming in and out of UK funds. For some time now, UK equity income has been one of the most unpopular categories, suffering months and months of withdrawals.

In the last month alone the category leaked over £500 million; this year overall, redemptions surpass £3 billion. As such, with just over a month left of the year, UK equity income is currently the fifth worst Morningstar category for outflows in 2022.

We’ve previously asked whether these income funds have an image problem, and as we focus on income this week, we’re having another look at the situation.

But despite a shift from growth to value and a surge in energy share prices, the picture has not really changed. The chart below shows that only six months out of the past 36 have had net inflows (which started roughly around the time of the Covid-19 pandemic lockdowns). Outflows around the £500 million mark have not exactly been uncommon.

Last year, Morningstar’s analyst Bhavik Parekh cited a lack of new funds as a reason for why UK equity income funds could be out of favour with investors.

"Many UK equity income funds have matured, meaning investors are withdrawing their assets for retirement or to invest in newer areas of the market such as in sustainable vehicles," he said at the time.

He also noted weak returns among the strongest dividend payers, like oil, banks and tobacco, contributed too – but in the past year, these types of stocks have fared a lot better than the rest of the market. So what's gone wrong?

Slow Reaction Times

There is often a disconnect between market performance and fund flows.

From our analysis, we often see investors pile in on trends after they’ve performed well. And subsequently, they get jittery in periods of underperformance, often fleeing at the bottom (just see last month’s record asset flows).

Moreover, value stocks have spent years out of favour and investors may be wary of returning to such categories, particularly after seeing them get battered by growth options during the pandemic.

If we look at the pandemic, dividends paid to UK investors fell by 44% in 2020, the lowest level since 2011, according to fund administrator Link. This bounced back with just under 50% in 2021 (much due to special dividends), and this year, UK dividends are forecast to hit £97.4 billion, up 5.5%.

Top and Bottom Funds

Within the category though, there are funds that have had been more popular and seen net inflows this year – 27 out of the total 90 vehicles, to be exact.

The most popular fund has been Vanguard FTSE UK Equity Income Index, largely thanks to a spike in April this year, but the fund has seen modest inflows for most of the year, and only two months of outflows. Another two popular funds are LF Gresham House UK Multi Cap Income and GAM UK Equity Income.

On the other hand, Trojan Income has definitely had the largest outflows, without a single month of net inflows for over two years. Royal London UK Equity Income and IFSL Marlborough Multi Cap Income have also struggled with popularity, and are the second and third worst funds for withdrawals.

What’s Next for Dividend Investors?

This week, UK Chancellor Jeremy Hunt is unveiling his Autumn Statement, and the government has floated the idea of raising taxes for dividends as part of an effort to address a £50 billion black hole in public finances.

A source close to Hunt has already confirmed the tax hikes were under consideration but said no decisions had yet been taken. This follows the reversed cuts to dividend tax from Kwasi Kwarteng’s mini budget.

Dividend tax rates are for the time being staying the same at 8.75%, 33.75% and 39.35% for basic, higher and additional rate taxpayers. Most investors can generally shield dividends with their ISA limits, so this change is likely to impact higher net worth individuals. People also have a £2,000 dividend allowance every year, which could be cut to £1,000 under Treasury plans or got rid of entirely.

Downing Street has also warned of "difficult choices" to come on tax and spending but pledged the government would ensure it was "acting fairly, protecting the most vulnerable and continuing to seek long term growth". That sounds good, but it's not necessarily brilliant news for income funds. You'll have to wait for Thursday to digest the precise outcome.

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Sunniva Kolostyak

Sunniva Kolostyak  is data journalist for Morningstar.co.uk

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