THE BLOG
04/03/2009 05:12 am ET | Updated May 25, 2011

Mutual Fund Fees Meet Bizzaro World

Bizzaro world is a fictional planet featured in DC comics. Everything there is the opposite of what it is supposed to be. In one episode, a bond salesman was enormously successful selling bonds that were "guaranteed to lose you money."

You don't have to visit Bizzaro world to have similar experiences. We have plenty right here on Earth.

In an article entitled Most Profitable Mutual Funds Ever, Max Rottersman listed the ten highest advisory fee grossing mutual funds since 1995. It was quite an eye-opener.

Topping the list was the mega Fidelity Magellan Fund. Its aggregate fees for 2000-2002 were in excess of $1.8 billion!

Active managers and their supporters are always talking about adding "alpha," which is a fancy way of measuring their excess returns over a given benchmark.

You would think a fund that charged its investors $1.8 billion would have generated a huge "alpha."

You would be mistaken.

I asked Sean Kelly, a Registered Investment Advisor with Kelly Associates, to run the numbers.

Here's what he found:

In 2000 and 2002, the Magellan Fund under performed the Fidelity Spartan 500 Index Fund, which is a good benchmark index fund from the same Fidelity family.

In 2001, it lost 11.65%. The index fund lost 12.05%. Just a smidgen of "alpha" in that year.

For the entire three year period, the Magellan Fund lost 38.83%, while the Spartan 500 Index Fund lost 37.70%.

Mutual funds are supposed to be held for the long term. How did the Magellan Fund perform for the period from 2000 through 2008?

Not well.

It lost 43.69%%. The Fidelity Spartan 500 Index fund lost 28.74%.

Not all funds on the list had negative alpha. It was a mixed bag. But that illustrates my point:

How is an investor supposed to pick the winners from the losers, when the vast majority of actively managed funds (over 95%) will under perform their benchmark over a ten year period?

What's the opposite of alpha? Negative alpha.

But I call it bizzaro. Which describes the behavior of investors who pursue "alpha" by purchasing actively managed funds.

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