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Behavioral Finance Isn’t A Perfect Science

Richard Thaler is considered to be one of the founding fathers of behavioral science and behavioral science.

Currently a professor of behavioral science and economics at the University of Chicago Booth School of Business, Thaler has published seven books and numerous articles, op-eds, and other publications on the topic of behavioral science over the years. In addition, Thaler is the director of the Center for Decision Research and is the co-director (with Robert Shiller) of the Behavioral Economics Project at the National Bureau of Economic Research.

Thaler recently released a new book entitled, “Misbehaving,” which gives a detailed history of how the field of behavioral finance originated and discusses some of the more common investment mistakes arising from behavioral biases.

It was these biases that Thaler sought to take advantage of when he established Fuller and Thaler Asset Management during 1993. Originally, two mutual funds were established based on behavioral theories: the Undiscovered Managers Behavioral Growth Fund and Undiscovered Managers Behavioral Value Fund.

After a decade of managing the behavioral finance funds independently, J.P. Morgan acquired the behavioral finance funds in January 2004. Fuller and Thaler continued as subadvisers.

Unfortunately, the performance of these two funds doesn’t do much to convince critics of behavioral finance that the topic is worth following.

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Behavioral Finance: Poor returns

The Undiscovered Managers Behavioral Growth Fund closed at the end October 2012. According to an archived version of the fund's fact sheet, from inception (7/30/98) to the end of March 2012 a $10,000 investment in Undiscovered Managers Behavioral Growth Fund, with dividends and capital gains reinvested, would have grown to $19,124, a return of roughly 5.1% per annum. An investment in the S&P 500 would have returned around the same over the period. During the ten years prior to the fund's closing, the Undiscovered Managers Behavioral Growth Fund returned 5.68%, with a hefty annual expense fee of 2.16%.

Behavioral finance fund returns
Behavioral finance fund returns

The Undiscovered Managers Behavioral Value Fund still exists and has produced an annual return of 10.9% per annum for the past 15 years -- a commendable record. Still, there are better funds out there, the Sequoia Fund, which was founded by one of Benjamin Graham's students and 'Superinvestors of Graham-and-Doddsville,' Bill Ruane. Over the past 20 years, the Sequoia Fund has returned 12.2% per annum, with a modest expense ratio of 1%.

Based on these performance figures then, it seems as if even the godfather of behavioral finance can't beat the market. Perhaps investors' behavior is not totally predictable? As it has been said many times before, investing is an art, not a science.