By Philip van Doorn, MarketWatch
Investors expect active money managers to outperform benchmark indexes. Many strategies can succeed in the long term, but it can be difficult for the average investor to wait patiently.
Raife Giovinazzo, the manager of the Fuller & Thaler Behavioral Small-Cap Equity Fund /zigman2/quotes/206849619/realtime FTHSX -1.04% /zigman2/quotes/210159846/realtime FTHNX -1.04% , described how he has made use of the research and theories of behavioral economist Richard Thaler to gain an edge on stock selection and timing by taking advantage of “mistakes” by investors, money managers and analysts.
Thaler, a professor at the University of Chicago Booth School of Business, was awarded the Nobel Memorial Prize in Economic Sciences in 2017 for his work in behavioral economics. Thaler has described that branch as “economics about humans” who don’t fit neatly into the behavior patterns assumed in traditional economic theory. Giovinazzo said his investment decisions revolve around “how people behave, as opposed to how they should behave.”
Fuller & Thaler Asset Management was founded in 1993 by Thaler and Russell Fuller. Daniel Kahneman, professor emeritus of psychology and public affairs at the Woodrow Wilson School at Princeton University, serves as an adviser to the firm. Kahneman was awarded the 2002 Nobel Memorial Prize in Economic Sciences for his work on psychological and experimental economics.
Kahneman was Giovinazzo’s undergraduate adviser at Princeton, and Thaler was his doctoral adviser at the University of Chicago Booth School of Business.
Fuller & Thaler Asset Management is based in San Mateo, Calif., and has $9.6 billion in assets under management in private accounts and mutual funds.
In an interview, Giovinazzo said: “Everything we do is based on behavioral finance — the study of investor mistakes.” Those mistakes can be summarized as overreactions and underreactions. “We try to buy when we think people are likely to overreact to bad news or underreact to good news.”
So Giovinazzo’s strategy combines value opportunities from overreactions to bad news with growth opportunities from underreactions to good news.
“People tend to overreact to a first impression and then they underreact to further impressions,” Giovinazzo said. If a company has turned a corner and become significantly more profitable, for example, analysts’ natural human behavioral biases may lead them to increase earnings estimates more slowly than they should.
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The Fuller & Thaler Behavioral Small-Cap Equity Fund tends to hold some cash to take advantage of buying opportunities, Giovinazzo said. “We were actually in the high single digits at the end of third quarter. When the prices dropped [the Russell 2000 Index was down 20% in the fourth quarter], we saw a lot of insider buying. We deployed cash and made a lot of purchases and went to a very low volume of cash.”
A company may be going through a difficult period, with selling pressure pushing its share price so low that insiders (senior managers of the company) begin buying shares. That’s when Giovinazzo will begin buying, assuming he is comfortable with his team’s fundamental analysis of the company.
“Our investment process looks for insider buying as the event that suggests that maybe the rest of the market is overreacting to these struggles,” he said. So the insider buying is a catalyst to further research that may lead to a buying decision.