UK equity income funds have been unloved by investors for some time. The category has seen consistent outflows for years, something we’ve noted time and time again in our monthly asset flows reports.
In the past month alone, UK equity income funds have leaked a net £664 million. So far this year, outflows are totalling £6.92 billion. Does equity income have an image problem?
As we can tell from the below graph, the fund category has not exactly seen many months of net inflows. Except for some obvious outliers, income funds have tended to lose about £500 million monthly.
By far the biggest inflow into UK equity income funds happened in December 2019 – however, the £894 million was drastically offset in January 2020 with £2.32 billion in outflows. Then something unexpected occurred: the category posted four straight months of inflows even as Covid-19 shut the world down, income stocks plunged in the market sell-off and dividends were slashed.
However, in total, dividends paid to UK investors fell 44% to £61.9 billion in 2020, according to fund administrator Link, the lowest level since 2011. Some two-thirds of UK companies cut or cancelled dividends between Q2 and Q4. At the lowest point of Q2, three-quarters of UK companies had cut or cancelled.
Morningstar’s asset flows expert Bhavik Parekh notes that there are two reasons in particular why UK equity income funds have been out of favour: weak returns and a lack of new funds.
“Firstly, some of the typically strongest dividend payers have tended to be those who have had relatively poor capital appreciation, e.g. oil, banks and tobacco, so while income may have been good, total returns (income and capital) have been behind funds without the income requirement and especially international funds,” Parekh says.
“Secondly, 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.”
If you look at our indices tracking dividend paying stocks, in the UK or around the world, they were significantly outperformed by broad global equity benchmarks in 2020. When the rebound came, this was largely led by technology companies not known for paying dividends. It is only in recent months that the larger picture has started to change. "Value" stocks, which are often dividend payers, made a comeback towards the back end of last year and into 2021.
If we look at the overall asset level of the UK equity income category though, investors’ attitudes are not having a significant impact. Total assets have hovered around the £60 billion mark since March and the shape of the chart is similar to the performance of the Morningstar UK Dividend Yield Index.
However, dividends are firmly back on the agenda again, as seen in our monthly update on the top FTSE stocks for dividends. Some of the best performing income shares this year have yields closer to 2%, suggesting that after last year’s crisis, UK investors do not necessarily have to choose between income and growth.
Moreover, the recovery for many value stocks like banks and oil companies continues and these names are likely to end the year with strong gains – proving Morningstar’s strategist Dan Lefkowitz’s predictions for 2021 right.
Earlier this year, he said that over the long term, dividend paying stocks are good bets as they tend to be solid businesses: “We know that a substantial portion of the long-term total return from equity markets actually comes from dividends, reinvested dividends from dividend growth. We know that dividend businesses tend to be solid, more stable in their cash flows. And we know that that commitment that a dividend payer makes to pay out some cash to shareholders on a regular basis, instils discipline and causes corporate management to steer a prudent course.”
