Do behavioural funds work story imageNo. Maybe. For all the impressive research on behavioural finance the acid test is ultimately whether it can yield better returns for investors. A few intrepid souls have set out to discover whether there's any evidence that investing along behavioural lines can produce such returns and have re-emerged from the mutual fund jungle, somewhat battered and worse for wear, with the broad answer of, err, "No, it doesn't".
Of course, there's a bit of a puzzle behind the research because the concept "behavioural investing" is somewhat amorphous. It would be unsurprising, given the parasitic mutational qualities of the financial sector, if the rise of behavioural finance didn't attract managers who see it as the next destination of hot money. It's enough to make your head spin: behavioural finance itself could be the next behavioural finance anomaly.

Behavioral Funds

In Behavioural Finance: Are the disciples profiting from the doctrine? some researchers from Florida State have taken a hard look at the rise of the behavioral mutual fund to try and figure out if these vehicles are providing investors with abnormal returns: that is, returns above and beyond what you might expect to get from simply investing in the market. The idea that the subject is a religion, its promoters disciples and the approach doctrinaire seems to beg the question a bit, but as an inveterate question beggarer myself I reckon we can reasonably skip that and look, instead, at the data.Now, the idea of a behavioral fund is a bit dubious in itself. Behavioural finance research shows that markets exhibit anomalous behaviour unpredicted by standard economic models while also showing that investors are predictably irrational in a variety of peculiar ways. The research has also been able to show correlations between these findings and thus explain various market anomalies. So far, so good.

From Market Anomalies to Investor Irrationality

However, we've also seen that merely pointing out these anomalies is often enough to cause human behaviour to adjust to make them disappear. The idea that markets are adaptive is a strong theme in finance at the moment, and the evidence is compelling if not yet overwhelming: one of the problems of adaptive models is that they can pretty much explain anything which, if not controlled for carefully, means they explain nothing. Still,…

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