The worst sectors for alpha generation still hide a few gems within them for investors keen to take an active approach, according to data from FE Analytics. 
FE Trustnet previously found that, on average, funds in the IA North America, Global, Emerging Markets and Japan sectors all failed to generate alpha against their relevant benchmarks over the past decade.
Alpha is measured by a fund's over- or underperformance when compared to its benchmark. As the benchmark is assumed to have a return of zero, positive numbers represent the value added by manager's abilities while negative values show a manager that has failed to provide higher returns.
Below, we look at why these sectors have underperformed on average and look at some of the individual funds that have generated the highest level of alpha against their own respective benchmarks.
The IA North American sector has long been considered a difficult market for active managers to outperform given its efficient nature.
On average, funds in the IA North America sector had an alpha generation score of -0.44 against the S&P500 over the past decade, with the sector underperforming the index by 28.26 percentage points.
Performance of sector vs benchmark over 10yrs
Source: FE Analytics
Sheridan Admans, analyst at The Share Centre, said: “With regards North America, it’s such a crowded market with a vast amount of information available at the fingertips of asset managers finding an edge is challenging.
Martin Bamford, chartered financial planner and chartered wealth manager at Informed Choice, added: “Actively managed funds tend to struggle to generate alpha in large, efficient, well traded markets.
“North America is probably the best example of a sector where active fund managers are inconsistent with alpha generation.”
As such, many prefer to use trackers and other passive vehicles to gain exposure to the market.
Bamford said: “We switched to using index trackers for North American equities exposure in our client portfolios nearly a decade ago, when it became apparent that active managers were so variable with their performance.”
Rob Morgan, pensions and investment analyst at Charles Stanley Direct, added: “In the IA North America sector managers taking a value based approach, of which there are quite a few, have struggled over this period.
“Funds that are not that differentiated from the index but charge higher fees than a passive fund are likely to also play a role. In the US it’s very hard to find active funds worth paying the higher price for over passive. Passive is a decent strategy when it comes to the US.”
The top fund for alpha generation in the sector is the $4.5bn Morgan Stanley US Advantage fund run by Dennis Lynch and his team, which has returned 256.28 per cent to investors over the past 10 years (4.99 alpha score)
The fund is heavily overweight consumer discretionary (35.42 per cent vs 12.03) and technology (27.99 per cent vs 20.77 per cent) stocks, with the likes of Amazon, Facebook and Alphabet all key overweights within its top 10 holdings.
Other notable alpha generating funds in the sector over the last 10 years include T. Rowe Price US Large Cap Growth Equity (4.57), Schroder US Mid Cap (3.56) and GAM North American Growth (3.55).
Away from the IA North American sector, the IA Global sector has been the worst sector for alpha generation with a score of -1.34 over the last decade.
Charles Stanley Direct’s Morgan said: “I think with global a number of active managers have been underweight the US on the grounds it is a more expensive market, but nonetheless it has outperformed.
“US large caps have done really well (and for UK investors recently aided by currency boost too) and this has helped passive investors. Therefore it is not necessarily bad stock picking that has been at fault for some underperformers but geographical allocations.”
The Share Centre’s Admans added: “The Global sector will be affected by the significant inclusion of North America as a major component in any global fund allocation.
However, not all agree that it is just an underweight to the US that has caused global funds to struggle, with Informed Choice’s Bamford noting that the large amount of choice can make it difficult for active managers.
He said: “For the Global sector, it’s the sheer size of the pool of stocks from which managers have to fish that creates the biggest challenge.
“When faced with a massive amount of choice, often accompanied by insufficient research across all stocks, active managers tend towards hugging the index and little opportunity for outperformance is available.”
Given the truly broad nature of the sector, it is unsurprising therefore that it has the biggest dispersion between the best and worst alpha generators in the sector (14.02).
Performance of sector vs benchmark over 10yrs
Source: FE Analytics
On average global funds have underperformed the MSCI World by 36.33 percentage points over the last decade, however the clear trend appears to be that funds concentrated on specific sectors have produced the highest level of alpha over the last decade.
Indeed, the top alpha generating funds against their relevant benchmarks in the space are specialist healthcare funds L&G Global Health & Pharmaceutical Index Trust (8.22), Schroder Global Healthcare (7.79) and Fidelity Global Health Care (6.97).
Away from healthcare, Morgan Stanley Global Brands (6.93) and Fidelity Global Consumer Industries (6.11) are other sector-focused funds with high alpha generation relative to their respective benchmarks.
Indeed the truly broad global fund with the highest alpha generation is Henderson Global Growth, run by FE Alpha Manager Ian Warmerdam and Ronan Kelleher, which has generated 6.06 alpha while returning 238.27 per cent to investors over the last 10 years.
Other top funds for alpha generation include Baillie Gifford Global Discovery (4.75), Orbis Global Equity (4.04) and MFS Meridian Global Equity (3.85).
Turning to Japan next – the final developed country where funds have on average failed to generate alpha (-0.78 against the TSE Topix).
Performance of sector vs benchmark over 10yrs
Source: FE Analytics
Charles Stanley Direct’s Morgan said: “Japan is more surprising, though again it is a market dominated by a lot of large companies and the effect of currency movements on large exporters.
“A lot of funds focus on small- and mid-caps and more domestically-orientated stocks and can get left behind when the yen falls and large cap exporters rally.”
The top fund for alpha over the last 10 years is the £256m Neptune Japan Opportunities run by Chris Taylor which has returned 146.57 per cent over the last 10 years – making it the third best performer in the sector.
However, the fund has struggled more recently and has been the worst performer in the sector over one- and three-year timeframes.
As such, Informed Choice’s Bamford suggests Baillie Gifford Japanese, run by Matthew Brett and Sarah Whitley. The fund has an alpha score of 2.84 and has been a top quartile performer over one, three, five and 10-year timeframes.
“This is a reasonably concentrated portfolio of around 60 stocks with around a third of the fund invested in its top ten holdings,” said Bamford.
“Conviction seems to be the solution to challenges delivering alpha, and in those sectors where market efficiency reduces opportunity for outperformance, concentrated portfolios with high conviction stock selection would be our preferred choice.”
Meanwhile, Rob Morgan says he likes the £1.5bn Man GLG Japan Core Alpha, which has an alpha generation score of 3.73 and has also been a top quartile performer over one, three, five and 10-year timeframes.
The fund run by Neil Edwards, Stephen Harker and Jeff Atherton “has a deep value approach that has worked over the long term,” Morgan said.
It is not only the developed markets above that has struggled, however, with the average fund in the IA Global Emerging Markets sector failing to generate alpha over the last 10 years (-0.47).
However, it is also the sector with the smallest spread from the best and worst alpha generators, with a score of 8.42 separating them.
The Share Centre’s Admans, said: “The problem is IA sectors are broad in their definitions and this can lead to difficulties defining an average fund other than by its position in a relative table.
“For example the sector returns don’t discriminate between those managers that target small and mid-caps over those that seek returns in large and giant caps.
“They don’t discriminate between a value manager and a growth manager or ones that attempts to blend their portfolio. And we know that market conditions can determine which of these types and/or styles will deliver superior returns under different economic backdrops.
“We also know that some managers will exclude some regions they will invest in while others maybe more inclusive.
“And when it has come to investing in emerging markets we have been in a very distinctive period where value investing was out of favour for some time and growth investing prevailed.”
The average fund has underperformed the MSCI Emerging Markets index by 15.82 percentage points over the last decade.
Performance of sector vs benchmark over 10yrs
Source: FE Analytics
However, Gary Waite, portfolio manager of Walker Crips’ Alpha/r2, says he is surprised by this as the market is under researched meaning there are some “gems” within the sector.
The top fund within the sector for alpha is the £1.5bn Aberdeen Emerging Markets Equity, which has returned 166.62 per cent over the last 10 years – the best in the sector.
In its latest factsheet, Square Mile Research said: “The unconstrained mandate and the emphasis on quality means that the fund can deliver a highly variable performance relative to the index, although in general, it has tended to defend well in falling markets.”
Other funds within the IA Global Emerging Markets sector include Aberdeen Global Emerging Markets Equity (3.64), Invesco Perpetual Global Emerging Markets (1.71) and Baillie Gifford Emerging Markets Growth (1.61).