“I’ve got opinions about the markets like everybody else,” he said. “But my market forecasts are wrong more than half the time.” He has learned how to make money by not acting on them.

Mr. Booth is the chairman and a co-founder of Dimensional Fund Advisors, a mutual fund empire that he began building in 1981, relying on the finance theory he learned at the University of Chicago.

Dimensional, sometimes called D.F.A., actively discourages short-term speculation and instead runs index-like funds suited for people and institutions with a long-term horizon. Its investing style is sometimes described as passive, though the firm is often an extremely active shareholder in the corporations in which it owns a stake.

A self-described “quant,” Mr. Booth, 66, earned an M.B.A. from Chicago in 1971 and he has put into practice some of the theories of the Chicago School, to which he has contributed in a very tangible way. In November 2008, he made a donation, worth some $300 million, that the university says is still the largest in its history. “It was payback time,” Mr. Booth said. “The school has given me a lot.” That’s when the school added “Booth” to its name.

Eugene F. Fama, a finance professor who is one of the school’s biggest stars, has been a Dimensional board member since the firm’s inception in 1981. Mr. Booth was Professor Fama’s research assistant and says his mentor’s theories are embedded in the company’s DNA. In an interview, Professor Fama said that “virtually all of D.F.A.’s products come from my research” and from work done in collaboration with Kenneth R. French, a finance professor at Dartmouth. Professor French is also a Dimensional board member.

Professor Fama, 74, is often called the father of the “efficient market hypothesis,” which assumes that market prices contain all of the relevant information available. In that sense, prices are “correct,” Professor Fama said. Extreme price volatility, which has occurred at intervals in recent years, may seem counterintuitive if markets are efficient, but he says wild price swings are “exactly what you’d expect from an efficient market that can’t make sense of the information it is receiving.”

One implication of the theory is that it’s quite hard to outsmart the market consistently. Mr. Booth says that at Dimensional, “we start by assuming that the market is smarter than we are.” That insight, which has been widely shared, led to the development of low-cost index funds at Vanguard and other companies that aim to match the market’s performance.

In his research, Professor Fama has found that over long periods and in many countries, there are anomalies in the general rule of market efficiency. Notably, small-capitalization stocks have tended to outperform those of larger companies, and value stocks have tended to outperform those that are more richly priced, he said. Dimensional’s original mutual fund, the US Micro Cap Portfolio, was designed to exploit that thinking.

The fund, which thrives today, differs from classic index funds in important ways, Mr. Booth and Professor Fama said. It is biased toward even smaller and more value-oriented stocks than its benchmark, the Russell 2000 index, and it reduces transaction costs by excluding some stocks.

That increases tracking error, a measurement of the fund’s deviation from the movement of the underlying index, but it seems to have been beneficial. The fund has had an average annual total return of 11.66 percent from its inception in late 1981 through last December, compared with 10.02 percent for the benchmark, Dimensional says.

The company had $262.1 billion in assets under management through December, it says. Morningstar ranks it as the eighth-largest mutual fund company in the United States. Vanguard is the biggest.

Dimensional is often considered an index fund company, and in an interview, John C. Bogle, the founder of Vanguard and creator of the first index mutual fund for retail investors, said that in Dimensional’s early days Vanguard handled much of its bookkeeping and administrative work. The two companies “parted ways amicably early on,” Mr. Bogle said.

“They may not call their funds index funds,” he said, “but they sure act like them.” He added that Dimensional’s funds were generally impressive, but he said he was “skeptical” about the merits of the company’s small-capitalization, value-oriented bias, saying that it was safer to mirror the overall market.

Mr. Bogle, who now heads an independent research institute on the Vanguard campus near Valley Forge, Pa., points out that while Vanguard’s funds are owned by its shareholders, Dimensional was set up as a profit-making company and has higher fees. According to Morningstar, while both companies offer low-cost funds, Vanguard’s are much cheaper.

Article source: http://www.nytimes.com/2013/03/17/your-money/david-booth-of-dfa-using-the-chicago-schools-theory.html?partner=rss&emc=rss