Evaluation and comparison of management strategies by Data Envelopment Analysis with an application to mutual funds

Wilson, Chester L.
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A new categorical schema for strategic management is developed; a methodology for its implementation is elaborated; an application to mutual funds based on microeconomic theory is demonstrated; and results which establish quantitative measures for evaluating strategies, improve measures of managerial performance, and establish a new viii method of evaluating portfolio performance with guidance for potential mutual fund shareholders is presented. The evaluation of strategies themselves depends fundamentally on distinguishing them from their execution, from their realization in practice. The accounting definition of strategy, “a plan of action used to guide or control other plans of action” finds an observable, indeed measurable, example in the strategic choices of mutual funds, which are required by law to declare and conform to the general strategy by which they conduct investment management. The methodology to exploit the declared strategies and performance data of mutual funds is Data Envelopment Analysis (DEA), a nonparametric linear programming method of analysis for use with empirical data. By producing a piecewise linear frontier based on the Pareto-Koopmans efficient performers, DEA provides a basis for measuring performances and facilitates sensitivity analysis. Data Envelopment Analysis measures assume no prior, underlying functional form (such as regression equations or production functions) to relate input to output or to other variables. An evaluation of a selected group of mutual funds illustrates the general DEA method and evaluates the actual performance of the funds. Then a new application involving an extended, three-stage Data Envelopment Analysis separates the performance of the investment strategies from the effects of managerial shortcomings and abilities to implement the strategies. This makes it possible to separately identify and evaluate what a strategy can accomplish. It also makes it possible to evaluate separately short-run from ix long-run performance. Finally, DEA identifies benchmarking possibilities for removing these short-run deficiencies. This new method for evaluating strategies and shortcomings in performance is demonstrated by application to mutual funds, which display striking contrasts in managerial performance and strategic potential. Although demonstrated with mutual funds, this method is not restricted to such applications. Indeed, the methods in this thesis provide a new way of evaluating investment potentials by distinguishing between actual short-run performance and long-run potentials.