Where in the world should you use active funds?

The problem is that it's not always that simple to tell which actively managed funds will outperform, and which won't. Around £20bn of UK investors' money is sitting in funds that have consistently underperformed for three years or more, showing that all too often investors get it wrong.

Making good decisions about where and when to use active or passively managed fund is important if you want to make your portfolio more efficient. Research by DIY broker Tilney Bestinvest on behalf of Investors Chronicle has revealed the geographical regions in which open-ended actively managed funds have beaten a relevant index over five years (31 August 2009 to 31 August 2014).

The research was carried out for six Investment Management Association (IMA) sectors listed below.

IMA Europe including UK

Pan-European funds saw a high success rate by active managers, 74 per cent of which outperformed the FTSE World Europe Index.

The best-performing funds were Waverton European B EUR D (IE00B1RMZ119), which returned 118 per cent, Digital Stars Europe GBP (LU0259627379), which returned 101 per cent, and JPM Europe Equity Plus A (dist)-GBP (LU0289230079), which delivered a 98 per cent return over the period.

The average outperformance of funds that beat the benchmark was 20 per cent, and the average lag of funds which trailed behind the index was lower, at 12 per cent.

Bringing up the rear is M&G Pan European A Inc (GB0030927700) and Carmignac Pf Gde Europe A EUR acc (LU0099161993), which both returned 34 per cent over five years. And with a slightly better performance is JPM Europe Strategic Value A (dist)-GBP (LU0119092640), which returned 35 per cent.

Go passive

There are very few Europe including UK tracker funds available to buy, possibly due to a lack of demand because most active funds manage to beat the index. However, if you do decide to go passive, try Vanguard's SRI European Stock fund (IE00B76VTL96), which is partially synthetically replicated and has a total expense ratio (TER) of 0.3 per cent.

Five year performance figures for IMA Europe including UK

Source: Tilney Bestinvest analysis of Lipper data

IMA UK All Companies

Some 61 per cent of active funds beat the FTSE All-Share Index over the past five years, which shows the strong capabilities of UK fund managers. In part, this reflects the superior performance of mid- and small-cap stocks over the period, with many active managers overweight these parts of the market compared with the All-Share.

Way out in front, the top-performing UK fund was MFM Slater Growth (GB00B8YPGL91), which returned an impressive 338 per cent over five years. In second place was Standard Life Inv UK Equity Unconstrained Ret(ISIN: GB00B0LD3C08), which produced 253 per cent, followed closely by Liontrust's Special Situations Fund (R) (ISIN: GB00B87GRQ11) which returned 250 per cent.

The average outperformance of funds that beat the index was 23 per cent, while the average underperformance was lower, at 13 per cent.

Go passive

Actively managed UK funds have shown greater ability to beat their benchmarks than funds in most other corners of the globe. However, you might prefer to keep costs low by investing in a tracker fund or an exchange traded fund (ETF), which aim to replicate the index as closely as possible.

If you've got a lump sum to invest, try SPDR's FTSE UK All Share UCITS ETF (FTAL), which earned a place in our Top 50 ETF list for 2014. It uses physical optimised sampling to track the performance of the FTSE All-Share, which means it may hold much fewer holdings than the constituents of the index. Although it includes the FTSE 100, the FTSE 250 and the FTSE Small Cap, it doesn't include micro caps in the FTSE Fledgling Index. It has a good two-year record of tracking the underlying index. It is also cheaper than rival FTSE All-Share ETFs with a TER of 0.3 per cent.

Vanguard's FTSE UK Equity Index (GB00B59G4893), which tracks the FTSE All-Share index is also a good, cheap option for UK exposure. Vanguard recently reduced the fund's annual fees from 0.15 per cent to 0.08 per cent a year, making it one of the cheapest UK funds available.

Five-year performance data for IMA UK All Companies

Source: Tilney Bestinvest analysis of Lipper data

IMA Europe ex UK

European funds without UK exposure haven't done as well as Europe including UK funds at beating their benchmark indices, with slightly fewer than half (48 per cent) of funds outperforming the FTSE World ex UK Index, and 52 per cent underperforming it.

The best performer over the period was IP European Opportunities Acc (GB00B28J0N53), which returned 108 per cent. F&P European All Cap Equity B Inc (GB0033403162) returned 92 per cent, while Jupiter European (GB0006664683) produced 90 per cent over the period.

The average outperformance for funds that beat their benchmark was 14 per cent, while underperforming funds fell short of the index by an average of 8 per cent.

The Europe ex UK funds with the smallest returns are the CIS European Growth Cavendish European Fund A (GB0009537407), and the Cavendish European Fund A (GB00B60SM439) which both returned 24 per cent over five years. And HSBC GIF Euroland Equity AD (LU0165074740) did slightly better, but is still in the bottom three with a 25 per cent return.

Go passive

Since less than half of actively managed funds have outperformed the index, investors might want to consider a tracker fund instead. Vanguard FTSE Developed Europe ex-UK Equity Index Accumulation (GBP) (VEUR) is ultra-cheap with a 0.12 per cent TER and fully replicates the index with physical holdings.

Five-year performance figures for IMA UK All Companies

Source: Tilney Bestinvest analysis of Lipper data

IMA Japan

Some 39 per cent of Japanese active funds outperformed, whereas 61 per cent underperformed the Topix index.

Way out in front is the Legg Mason Japan Equity A (GB0033507467), which returned 167 per cent over five years. Also top of the pack were CF Morant Wright Nippon Yield A (GB00B2R83902) and Baillie Gifford Japanese A (ISIN:GB0006010838), which both returned 57 per cent over the period.

The average outperforming fund produced a return 19 per cent bigger than the index, while the average underperforming fund lagged it by 9 per cent.

Bottom of the Japanese pile is GAM Star Japan Equity GBP Acc (IE0003014135), which returned a tiny 2 per cent over five years. Meanwhile, Fidelity Japan Acc (GB0003877817) returned less than 2 per cent a year over the period with a 9 per cent return, while AXA Rosenberg Japan R (GB0007371718) delivered a feeble 12 per cent return.

Go passive

Investors looking for a cheaper index-tracking fund could opt for HSBC Japan Index (ISIN: GB00B80QGN87), which aims to track the FTSE Japan Index. It has a reasonably cheap annual cost of 0.21 per cent.

Five-year performance data for IMA Japan

Source: Tilney Bestinvest analysis of Lipper data

IMA Global Emerging Markets

In this sector 34 per cent of active funds beat the MSCI Emerging Markets TR Index, whereas 66 per cent undershot it. That may come as a surprise, as the 'less researched' emerging markets are often cited as an area where active management has greater scope to outperform.

The mass underperformance may be because many active funds focus on the major economic opportunities whereas the index is based on the liquid free float available today and therefore skewed to the companies with the greatest liquidity.

Emerging markets were the worst of any geographical region, in terms of absolute returns. The top performers were Aberdeen Global Emerging Mkts Sm Cos D2 (LU0278932362), which has returned 102 per cent, First State Glbl Emg Mkts Sustblty A GBP (GB00B2PDTV12), which has returned 95 per cent, and McInroy & Wood Emerging Markets (GB00B1RWXF12), which returned 75 per cent over the period.

The average outperformance was 19 per cent and the average underperformance was marginally more at 20 per cent.

The worst-performing emerging markets fund was FP Hexam Global Em Mkt A (GB00B3CTJJ73), which lost 25 per cent over the period. Templeton Global Emerging Markets A Acc (GB0034009190) only just held its value with a tiny 0.4 per cent return, while HSBC GIF Global Emerging Markets Eq A Inc (LU0054450605) managed to return 9.3 per cent over the period.

Go passive

For passive global exposure try Powershares FTSE RAFI All World 3000 UCITS ETF (PSRW), which will give you a broad selection of stocks in both developed and emerging markets, focusing on stocks it perceives as inexpensive.

Powershares invests in an index put together by FTSE and RAFI that focuses on companies' economics and disregards their stock market value, so it can find cheap stocks. It has a TER of 0.5 per cent, which is reasonable considering it invests in emerging markets, usually an expensive area to own.

Five-year performance data for IMA Global Emerging Markets

Source: Tilney Bestinvest analysis of Lipper data

IMA Global

Only 15 per cent of actively managed Global funds outperformed over five years, an "abysmal" rate of success, according to Jason Hollands, head of business development at Tilney Bestinvest. And there is a very clear reason for this, he says. Global funds aimed at UK investors are almost always underweight the US compared with the index, as these funds aim to provide investors with market diversification.

However, the MSCI World TR Index, because it is market-cap weighted, has a 56 per cent exposure to the US. The US has of course delivered stellar returns in recent years, so this has made it difficult for global managers to beat the index while remaining diversified. Furthermore, the waters are muddied a little further by the sector including a number of resources and ethical funds, Mr Hollands explains.

The top performers were Henderson Global Growth Acc (GB00B68SFJ13), which returned 216.95 per cent over the period, followed closely by Schroder Global Healthcare A Acc (GB00B76V7Q08) (212.33 per cent return) and Old Mutual Global Equity A Acc (GB00BHBX7W72) (209.93 per cent return). All three funds carry management fees of 1.5 per cent, which is slightly higher than the sector average (1.35 per cent), but clearly worth it for the stellar performance.

The average outperformance of the benchmark was 14 per cent, while the average underperformance was 21 per cent, showing that a number of funds have severely lagged the index.

The weakest performers were M&G Global Basics A Acc (GB0030932452), which returned 133 per cent, CF Lacomp World (GB0008826629) with a 115 per cent return, and bottom of the pile was First State Global Resources A GBP Acc (GB0033737874), which only managed a return of 111 per cent.

Go passive

iShares MSCI Emerging Markets Minimum Volatility (EMMV) is a good option for investors who want a smoother ride in emerging markets. It aims to reflect the performance of a subset of securities within the MSCI Emerging Markets Index with the lowest absolute volatility of returns, subject to risk diversification. It is traded in US dollars on the London Stock Exchange. This ETF reinvests income and its TER is 0.4 per cent.

Five-year performance data for IMA Global

Source: Tilney Bestinvest analysis of Lipper data