* Dividend funds, index trackers dominate inflows
* Foreign buyers put off by sterling slide
* Handful of large-caps soaking up flows
* GRAPHIC: FTSE 100 vs FTSE 250: http://bit.ly/2e3GHSu
* GRAPHIC: The pound's slide: http://tmsnrt.rs/2egbfVh
By Vikram Subhedar
LONDON, Oct 13 (Reuters) - As sterling plumbs the depths,foreign investors are withdrawing from British stocks andleaving domestic funds to push the benchmark bluechip index torecord highs - for now.
But some investors are growing nervous about how long thesterling-based funds, insulated from the pound's slide and drawnby healthy dividend yields, will continue to fill the gap.
The FTSE 100's sharp recovery from lows after Britons voted to leave the European Union in June stands instark contrast to a darkening outlook for the pound and thedomestic economy.
In sterling terms, London-listed stocks have raced to theirhighest ever levels even though investment funds have continuedto bleed money, share valuations are near multi-year highs andthe outlook for earnings remains muted.
Data from Thomson Reuters Lipper shows that from June toSeptember, UK-focused equity funds suffered outflows of morethan 3 billion pounds ($3.73 billion).
Much of this appears to have been pulled by investors basedin dollars or euros. While the FTSE is up nine percent from theEU referendum day of June 23, the pound has lost 18 and 15percent respectively against their home currencies - wiping outtheir notional gains.
At its latest policy meeting, the Bank of England notedestimates from S&P Global Market Intelligence suggesting thatnet purchases of FTSE 100 shares by non-residents in July andAugust were about half of the average monthly inflows last year.
Still, the FTSE 100 rose 13 percent from June to Septemberand is up by more than fifth since its lows in July followingthe shock referendum result.
The composition of the UK index along with the kind ofinvestors active in the market helps to shed some light on whatis underpinning stocks.
Dominated by large, dividend-paying, global companies - manyof which receive a big earnings boost when they bring offshorerevenues home thanks to the weak pound - the FTSE 100 hit thesweet spot in a world where yields on investments are scarce.
With yields on British government bonds near rock-bottom,this is particularly the case for domestic investors for whomcurrency is less of a factor.
"The UK remains an attractive place for investors seekingdividends; there are 15 companies with an indicative dividendyield of over five percent, which is significant when comparedto the one percent yield on 10-year gilts," said MatthewBeesley, a portfolio manager and Head of Global Equities atHenderson Global Investors.
Less than 10 percent of the roughly 600 UK-focused equityfunds tracked by Lipper have enjoyed net inflows since June.Inflows are heavily skewed towards so-called income funds, whichaim to pay their unit holders dividends, and tracker funds,which passively buy stocks in a given index.
Nick Train's $3 billion UK equity fund, which had a fifth ofthe fund in shares of drinks group Diageo and consumergoods giant Unilever at the end of September, attractedthe most inflows with more than $440 million.
LOP-SIDED
Both Diageo and Unilever exemplify the kinds of major stocksthat investors have increasingly gravitated to since the Brexitvote, drawn by their dividends, relatively low reliance on theBritish economy and the boost from offshore revenues.
British fund supermarket Hargreaves Landsdown,which caters largely to domestic retail investors, on Thursdayposted record profits and assets under management for its latestquarter, but said investors' confidence had fallen and thiscould weigh on future business.
Equity income funds were in demand in a low interest rateenvironment, chief executive Ian Gorham told Reuters.
The large dividend payers are also among the biggest listedfirms in the UK and with the FTSE 100 weighted bymarket-capitalisation, the larger a firm the more influence itswields on the index's moves.
Just 10 large stocks make up nearly half the market-cap ofthe FTSE 100. Exchange-traded funds (ETFs) based on the index,which overwhelmingly favour bigger stocks, are the only othergroup to have seen inflows since June.
Oil majors BP and Royal Dutch Shell and emerging markets-focused banks HSBC and drugs groupAstraZeneca, are all big outperformers and have been keyin lifting the broader index.
Eric Moore, a portfolio manager of the Miton UK Income fundwho holds AstraZeneca shares, says the company is one among ahandful that pays out dividends in appreciating U.S. dollars,making them even more attractive to British investors.
"It may be a one-off mechanical adjustment but right here,right now the impact is real. It's money in the bank," saidMoore, who adds, however, that the sustainability of dividendsare a concern as payouts have grown faster than a recovery incorporate profits.
FOREIGN VIEW
The view from across the Atlantic is less sanguine.
Offshore investors are less enthusiastic about investing inUK assets due to the growing likelihood of a "hard" Brexit - inwhich Britain leaves the EU's single market in order to imposecontrols on immigration, disrupting access to its main tradingpartner.
More than half of UK stocks are held by overseas investors,according to the latest data from Britain's Office for NationalStatistics. Foreign holdings were less than 10 percent in the1970s and 1980s, and stood at around 35 percent at the turn ofthe century.
Cumberland Advisors, a Florida-based investment firm thatuses mostly ETFs, points out that the main UK ETF used by U.S.investors, the iShares MSCI United Kingdom ETF, has lostmoney this year. A currency-hedged version is up, though thefund's assets under management are considerably smaller.
Bill Witherell, chief global economist at CumberlandAdvisors, said a weaker pound is positive for UK multinationalfirms only as long as single-market access continues.
"The prospect of a weaker domestic economy and heightenedpolicy uncertainty lead us to maintain our maximum underweightof the UK in our International, Global, and Tactical Trend ETFPortfolios," said Witherell.
The FTSE 100's climb above the 7,000 point level has takenvaluations to 16 times forward earnings, close to the highest ina decade.
It has brought back some uncomfortable memories. The threeinstances when the index was around these levels were justbefore the dotcom bust in 1999-2000, the collapse of theNorthern Rock bank in 2007 and during last year's Greek debtcrisis.
"After 20 years in the business, I can't help but feel alittle jittery about the FTSE around here," said Moore.
($1 = 0.8042 pounds)
(Additional reporting by Danilo Masoni in MILAN and SimonJessop in LONDON, Editing by Mike Dolan and David Stamp)
