A Nobel Prize in economics doesn’t necessarily translate into money-management prowess.
However, a pair of mutual funds based on Richard Thaler’s groundbreaking work in behavioral finance, which earned him the Nobel in economics earlier this month, are putting in solid performances, so far.
Thaler is a principal at Fuller & Thaler Asset Management, which defines behavioral finance as “the combination of cognitive psychological theory and conventional finance to provide explanations for why people make irrational investment decisions.”
This firm is the investment adviser behind the Fuller & Thaler Behavioral Small-Cap Equity Fund FTHNX, +1.25% a mutual fund that “aims to capitalize on behavioral biases that may cause the market to over-react to old, negative information or under-react to new, positive information,” according to the adviser’s website.
“There are two kinds of mistakes that produce buying opportunities: over-reaction and under-reaction,” the fund’s prospectus reads. “Other investors may over-react to bad news and losses (e.g., panic), or they may under-react to good news (e.g., not pay attention).”
In developing the fund’s portfolio, Fuller & Thaler looks for events “related to insider buying, earnings announcements, and other news that suggest these types of investor misbehavior,” before assessing the company’s fundamentals.
“If Fuller & Thaler determines that an investor mistake is likely and the company has solid fundamentals, the portfolio managers generally buy the stock.”
The fund, which has maintained a five-star rating from Morningstar for five years, has outperformed the comparable Russell 2000 RUT, -0.92% consistently since its inception in 2011. It has gained 18.3% over that period, compared with the 15% rise of its benchmark. (Those performance statistics, from the fund’s website, are through the end of June.) The fund’s investor share class charges an expense ratio of 1.07%, and the fund has about $246.5 million in assets.
Thus far this year, the fund is up 14.7%, above the 10.9% rise of the small-cap Russell.
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Much of Thaler’s work as an economist concerns what he calls “nudges,” or ways to incentivize actions. For example, it has been estimated that his theories on auto-enrollment and auto-escalation in workplace savings accounts have added nearly $30 billion to retirement accounts over the past decade.
Another Thaler-related fund has also posted strong historical results: the Undiscovered Managers Behavioral Value Fund UBVLX, +0.46% which is subadvised by Fuller & Thaler Asset Management but distributed on a limited basis by J.P. Morgan.
The fund “looks for companies with significant insider buying and share buybacks—which are strong indicators of future return potential following an underperformance in the stock price. The team seeks to lock in gains by selling stocks with large amounts of insider selling, new share issuance or when M&A activity occurs.”
The Undiscovered Managers is up 8.4% thus far this year, compared with the 4.9% rise of the Russell 2000 Value Index RUJ, -0.66% The following FactSet chart compares the fund (in gray) against both the Russell 2000 (green) and the Russell 2000 Value index (blue) over a 15-year period.
Thaler doesn’t appear to be directly involved in the management of the funds. Fuller & Thaler didn’t respond to a request for a comment.
This kind of long-term outperformance is rare for actively managed funds, where the components of the portfolio are individually selected by a manager or team, as opposed to passive funds, which simply track an index by holding what it does, and in the same proportion. According to Morningstar data, only 38.3% of small-cap value funds have beat their benchmark over a 15-year period.