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FUNDamentals: An Envelopment-Analysis Approach to Measuring the Managerial Quality of Mutual Funds

(Logan G. Platt, 1993)

The dramatic surge in the proliferation of mutual funds over the past decade has resulted from spectacular market performances as well as the ease of accessibility of the investment instrument to the general public. In 1982 only 857 mutual funds existed; there are now well over 3,100. For the individual investor, such an explosion in the number of funds makes choosing the right fund ever more difficult. Many resources are available to the individual investor to aid in fund selection decision-making. These resources, such as newspapers, books, newsletters, and subscription services, often contain statistics and two-dimensional financial ratios that can aid in the speculation of fund management quality.

However, since fund managers face a myriad of decisions in operating their funds, a good, descriptive model should consider multiple input and multiple output variables. According to Barr, Seiford, & Siems (1991), ``using a single input/output ratio to assess management quality, as many researchers have done, is unrealistic; a multidimensional approach is required.'' This paper presents a new approach for quantifying fund management quality, using a data envelopment analysis (DEA) model that combines multiple inputs and multiple outputs to compute a scalar measure of efficiency and quality that can be used to rank funds by relative management efficiency.

An analysis of 100 growth-objective mutual funds over the five-year period from 1987 to 1991 reveals significant differences in management quality in providing the investor with an appropriate return at a given risk level with a significant reduction in investment costs. A linear programming procedure is presented to evaluate the relative efficiency of growth mutual funds and a ranking of 36 ``most efficient'' funds is provided. Finally, statistical tests reveal that ``more efficient'' funds have significantly higher five-year average returns while maintaining significantly lower risks and investment costs than their ``non-efficient'' competitors. Hence, this new metric provides a level of assurance that investors can get more investment return for their dollar by focusing on the relative efficiency and quality of mutual fund management.


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Next: Production Center Analyses and Up: Selected Senior Design Project Previous: Analysis of Production of

Richard S. Barr
Fri Feb 17 16:09:51 CST 2006