The UK income tracker fund the pros struggle to beat

The UK stock market has a rich dividend heritage and is one of the world’s highest-yielding markets, which is why there’s no shortage of UK equity income funds and investment trusts competing to appeal to investors.

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With income funds, various approaches are taken with some focusing on generating a high level of income (typically yielding 5%-plus), and others seeking to deliver solid capital gains while generating income growth.

For funds with high yields, it can be tricky to consistently get the balance right in terms of delivering compelling overall total returns – capital and income combined.

However, it may surprise some investors that a high-yielding UK equity income fund, with a remarkable track record of outperforming most UK equity income fund rivals over multiple time periods, doesn’t even attempt to beat the wider market.

Vanguard FTSE UK Equity Income Index, one of interactive investor’s Super 60 investment ideas, has comfortably outperformed the UK equity income sector average over one, three, five, and 10 years.

Its ranking in the sector over those periods is seventh out of 65 funds over one year, 12/65 over three years, 9/63 over five years, and 8/54 over 10 years.  

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As well as performance beating many fund managers, the fund generates a higher yield than the wider market, currently 4.3%. This is because the index it follows – the FTSE UK Equity Income index – consists of shares “that are expected to pay dividends that generally are higher than average”.

In contrast, most actively managed UK equity income funds tend to yield between 3.5% and 5%, with a small number offering 5%-plus. This is due to most funds aiming to strike an appropriate balance between risk and reward in an attempt to deliver both capital growth and income.

Therefore, the Vanguard fund’s performance and income generation is heavily influenced by the biggest FTSE 100-listed dividend stocks. Its top holding, British American Tobacco (LSE:BATS), accounts for 5.7% of the fund. This is followed by 4.8% held in National Grid (LSE:NG.) and 4.6% in Reckitt Benckiser Group (LSE:RKT). The rest of the top 10 holdings, where weightings range from 4.6% to 4.2%, are Unilever (LSE:ULVR), Shell (LSE:SHEL), BP (LSE:BP.), Barclays (LSE:BARC), GSK (LSE:GSK), Rio Tinto (LSE:RIO) and Lloyds Banking Group (LSE:LLOY).

The top 10 holdings and weightings differ from a typical tracker fund as they don’t have an income mandate and are instead seeking the market return of the FTSE 100. The Vanguard FTSE 100 ETF (LSE:VUKE), for example, has pharma giant AstraZeneca (LSE:AZN) as its top holding at 7.8%. Its top 10 features HSBC (LSE:HSBA) (a 7.4% weighting), Rolls-Royce Holdings (LSE:RR.) (4%), RELX (LSE:REL) (2.8%) and BAE Systems (LSE:BA.) (2.4%).

When pitting its performance against the FTSE 100 and FTSE All-Share, it has outperformed over one, three and five years, but underperformed over 10 years.

Source: FE Analytics. Data to 18 September 2025. Past performance is not a guide to future performance.

Investment trusts have an income edge

Investment trusts have bells and whistles that set them apart from funds, with one tool in their armoury proving particularly attractive to income-seeking investors.

Investment trusts can hold back up to 15% of the income generated from the underlying holdings each year. In leaner periods, such as during the global financial crisis and the Covid-19 pandemic, many investment trusts maintained or increased their dividends by dipping into income retained during better times.

Last week, City of London (LSE:CTY), also a Super 60 constituent, upped its dividend for the 59th consecutive year.  

Nine other trusts that have raised their dividends for at least half a century are: Bankers (LSE:BNKR), Alliance Witan (LSE:ALW), Caledonia Investments (LSE:CLDN), The Global Smaller Companies Trust (LSE:GSCT), F&C Investment Trust (LSE:FCIT), Brunner (LSE:BUT), JPMorgan Claverhouse (LSE:JCH), Murray Income Trust (LSE:MUT), and Scottish American (LSE:SAIN). 

In contrast, most funds cut dividends as they cannot hold back income and are required to pay investors all the income received each year. So, when there’s a shortage of dividend cheques during challenging times, funds have no get-out-of-jail-free card and dividend cuts are pretty much inevitable.

For funds, investors need to decide whether to pick the accumulation share class (the income is reinvested) or the income share class (the income is paid out).

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However, in terms of overall total returns, Vanguard FTSE UK Equity Income Index has outperformed the average UK equity income investment trust over one, three, five, and 10 years. It is a smaller sector compared to funds, comprising just 18 investment trusts.

Its ranking in the sector over those periods is eighth out of 19 funds over one year, 5/19 over three years, 6/19 over five years, and 7/19 over 10 years. 

Source: FE Analytics. Data to 18 September 2025. Past performance is not a guide to future performance.

Best of both worlds

As well as low costs, another key attraction of owning the market through an index fund or exchange-traded fund (ETF) is simplicity. Investors know from the outset what they will get - close to the return of the index.

Given that most index funds and ETFs are seeking to closely replicate a particular market or group of companies, such products don’t aim to outperform, but they are unlikely to notably underperform an index either.

Rather than backing one approach over the other, having some funds managed by professionals and some that track the market can work well in a diversified portfolio. With active funds, the key is to look under the bonnet and understand how the fund is investing and what it seeks to achieve.

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As part of your research, examine a fund’s top 10 holdings, compare those holdings with the index, and look at how the fund has performed versus a comparable index over different periods such as one, three, and five years. If the performance line of the fund is quite similar to the index, this could be a sign that the fund manager is not taking enough active bets, so not investing differently enough from the index. 

Certain stock markets prove to be a tougher nut for active managers to crack. The S&P 500 index, for example, is notoriously difficult for fund managers to consistently beat, given that it is the most widely researched and followed index.

By the same token, active fund managers who invest in small companies tend to have a greater percentage of outperformers. Smaller stocks tend to be more volatile and less well researched than large companies, which gives active managers a better chance of beating a benchmark that simply owns stocks according to their size.