Investors Pulling Out of UK Equity Funds
Ben Pattinson discusses the future of declining equity funds in the UK, as well as the ramifications on the UK economy.
Between June and August of 2020, investors pulled out a whopping £1.2 billion from UK equity funds[i] as a result of both the Coronavirus pandemic and Brexit uncertainty.[ii] This news is very significant for the UK economy, but first, this article will establish what an equity fund is, what is causing investors to pull out of equity funds, and where investors are putting their money instead. Finally, the article will look at the commercial implications of investors pulling out of UK equity funds.
What is an equity fund?
An equity fund is an investment vehicle that invests in stocks (shares of a company).[iii] Individuals, companies and pension funds can invest their money in equity funds hoping that they will earn a return on the shares that the equity fund has invested in. Equity funds will receive a return on their shares via a dividend (money paid out by the company to shareholders) or selling their shares at a profit. This return will then be shared among the individual investors in proportion to the size of the investment in the equity fund or based on contractual arrangements agreed between the investor and fund manager. When individual investors invest money into the equity fund, they become shareholders of that fund. The diagram below should help clarify this.
Equity funds are managed by a portfolio manager whose performance tends to be made public, so individuals have access to more information to decide which equity funds to invest in. This is common practice in the industry to attract more investors to invest in equity funds. The portfolio manager can decide whether to invest the fund into specific sectors, such as retail, or diversify more broadly. A diverse investment strategy is beneficial because it can help to spread the risk of loss. A portfolio manager is usually compensated from a cut of the returns made by each investor.
Why are investors pulling out of UK equity funds?
Individual investors are pulling out of equity funds because they lack confidence in gaining a return from UK shares. Covid-19 has caused many companies to cut their dividend payments as consumer demand has plummeted, meaning their profits have decreased, cash flow issues have arisen and therefore, companies are less able to pay out dividends. Consequently, individuals who have invested their money in an equity fund will be unlikely to make a return. For example, Royal Dutch Shell cut their dividend by two-thirds in the first quarter of this year.[iv] Between April and June, UK shareholder payouts were down by £22 billion.[v] The lack of returns on shares in UK companies means that investors are moving their money out of equity funds and into investments where they can get a return. Equity funds also gain profits for the investors by selling the shares they own in companies. However, as profits are low, the value of the shares may have decreased, which means if the equity funds sell the shares they are unlikely to make a significant profit.
The lack of a trade agreement with the EU and the fast-approaching deadline of the transition period at the end of December has also knocked on investors’ confidence in gaining a return from UK shares. A lack of a trade agreement means the UK will fall out of the single market which will make buying goods abroad more expensive due to tariffs. Additionally, tariffs would make British exports more expensive to European countries and therefore make it harder to sell British goods to the EU.[vi] This will mean that companies’ profit margins will be lower as they pay more for foreign goods, and also may lose profit if they supply goods to the EU, as European countries may look for other suppliers where they will not have to pay tariffs. The lower profits will mean the return to equity funds shareholders will be reduced. For this reason, individual investors are taking money out of UK equity funds.
If investors are pulling out of UK equity funds, where are they putting their money?
Put simply, investors want a return on their investment. This means investors will put their money where they can gain the greatest return. Consequently, there is a greater inflow of money into foreign equities which are more stable such as large technology companies in the US. Additionally, European equity funds have grown popular with UK investors because they have relatively cheaper share prices.
What are the effects of investors pulling out of UK equity funds?
Firstly, UK equity funds themselves will lose profits as fewer individuals are purchasing shares in them. Without any sufficient investment going into the funds, the funds will be unable to invest in the high volumes which earn sufficient returns. Secondly, equity is an important way in which UK companies raise finance as they do not have to pay it back, compared to debt, which must be paid back plus interest on the loan. The lack of equity will mean companies will have to finance their activities by incurring debt (borrowing money) instead. The good news for companies is that interest rates are at a record low.[vii] Moreover, the Bank of England may be considering negative interest rates, which means borrowing money will become even cheaper.[viii] However, as many companies are less able to pay off existing debts due to smaller profits as a result of the pandemic, they may be unwilling or unable to take on even more debt to try and balance their cash flows. Overall, investors pulling out of UK equity funds indicates a lack of confidence in UK companies and the UK’s handling of Covid-19 and Brexit.
Written by Benjamin Pattinson.
[i] Investors pull 1.2 billion from UK equity funds on no-deal Brexit fears- https://www.funds-europe.com/news/investors-pull-12-billion-from-uk-equity-funds-on-no-deal-brexit-fears [ii] Investors exit UK equity funds on pandemic and Brexit fears- https://www.ft.com/content/a456d743-419d-4dc5-ae43-83d2995616fe [iii] Equity Fund- https://www.investopedia.com/terms/e/equityfund.asp
[iv] Shell cuts its dividend for the first time since World War 2- https://www.ft.com/content/27f338e3-9a46-422e-9d24-8254cdc35e48
[v] UK companies slash dividends by 57%- https://www.ft.com/content/ec1eb3a9-95b9-4431-8879-60650f859665 [vi] Brexit: All you need to know about the UK leaving the EU- https://www.bbc.co.uk/news/uk-politics-32810887 [vii] BoE cuts rate to record low of 0.1%- https://www.ftadviser.com/your-industry/2020/03/19/boe-cuts-rate-to-record-low-of-0-1/ [viii] Negative rates explained: should UK investors prepare? https://www.schroders.com/en/insights/economics/what-happens-if-uk-interest-rates-turn-negative/