Data Envelopment Analysis of Morningstar's Small-Cap Mutual Funds

Only 11 of the 58 sample small-cap mutual funds are DEA efficient, and, of these, value funds represent by far the largest percentage. Twenty-five funds are least inefficient and 22 are inefficient. The mutual funds that are managerially inefficient tend to have the largest values for the seven investment style variables: Morningstar Risk, beta, P/E ratio, P/B ratio, P/CF ratio, three-year earnings growth rate (%), and median market cap ($mil). These relationships are consistent with the growth style of portfolio management. Thus, as defined by the DEA analysis, these findings indicate that the growth style of portfolio management is more prone to being managed inefficiently. The next two statistical findings indicate that mutual funds that are managerially inefficient tend to have the smallest values for percentages of bonds other securities and foreign securities. These findings also indicate a more aggressive style of portfolio asset allocation that is more prone to being managed inefficiently. And, the last statistical finding indicates that mutual funds that are managerially inefficient tend to have smallest total assets. This finding indicates that these smaller sized funds are more prone to being managed inefficiently. And, the efficient funds being the largest ones ($3.3 billion mean, indicate they have not reached the size of reduced management efficiency. This latter finding is consistent with those by Latzko (1999). Mutual funds benefit from scale economies over the full range of fund asset sizes, but the largest declines in expenses occur prior to about $3.5 billion in total assets. Therefore, it is likely that the largest funds are prone to less management efficiency within the next size category, mid-cap funds. The overall evidence indicates that small-cap mutual funds with largest total assets are the most managerially efficient, as defined by DEA. And, this efficiency comes with conservative portfolio investment style attributes consistent with a strong value style of investing