Russell Fuller picks stocks based on what he calls other investors' mistakes.
Russell Fuller, whose U.S. mutual fund returned almost twice as much as the Standard & Poor’s 500 index last year, picks stocks based on what he calls other investors’ mistakes.
The Undiscovered Managers Behavioral Value Fund bought shares of General Cable, a maker of electrical wire, in August 2002 after the stock dropped 85 percent in little more than a year. General Cable’s stock price has since more than tripled.
The $92 million fund took a stake in software-developer NetIQ in November 2003 after its shares tumbled about 90 percent. NetIQ’s stock has risen 32 percent since mid-August.
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“What we try to do is understand what causes people to make mistakes,” Fuller said from his office in San Mateo, Calif.
Behavioral finance, a field in which Fuller has been a key author and practitioner, contends that systematic errors by investors cause stocks to be mispriced.
Fuller’s fund gained 21 percent last year, beating 87 percent of competing value funds and the 11 percent return of the S&P 500, according to data compiled by Bloomberg News. During the past three years, the fund outpaced 95 percent of its rivals, rising at an annual rate of 16 percent.
“The fund has an interesting premise provided the manager can maintain his ability to recognize where behavior pushes stocks to ridiculously” undervalued levels, said Iain Beattie, an investment consultant at Watson Wyatt in Edinburgh.
Fuller was finance-department chairman at Washington State University before founding his own investment company in 1993.
Five years later, the firm’s name became Fuller & Thaler Asset Management, reflecting the ownership and role of Richard Thaler, a University of Chicago professor and pioneering scholar of behavioral finance.
Fuller & Thaler, which now manages $3.2 billion, runs the 6-year-old value fund for JPMorgan Chase & Co., which acquired the Undiscovered Managers funds in 2003.
The $150 million Undiscovered Managers Behavioral Growth Fund advanced 10 percent in 2004.
Behavioral finance combines the fields of economics, finance and psychology. Researchers have found that investors often make errors such as failing to react quickly enough to new information that challenges their existing opinions.
The behavioral strategy has “a whole lot of merit” because Wall Street coverage of small companies is spotty, said Jeffrey Ptak, an analyst at Morningstar, a fund-industry research firm in Chicago. Fuller’s fund invests in about 80 companies with market values averaging less than $1 billion.
In a 1985 study, Thaler and DePaul University professor Werner De Bondt found that the 35 worst-performing U.S. stocks in every three-year market period from the Depression to 1980 had an average yield of 20 percentage points more than their benchmark during the subsequent three years.
“Long-term losers tend to become long-term winners,” Fuller said.
While most managers’ bias is to shun the poor performers, Fuller said his job is to select “losers” with the best growth prospects. He estimates that 95 percent of stocks are efficiently priced and about 3 percent are underpriced.
Besides finding stocks with low stock prices relative to book value, the managers track stock-trading patterns by company insiders and share-buyback programs, Fuller said.
His fund purchased shares of General Cable near the end of “an ugly period” in which its stock plunged to $2.28 a share in October 2002 from a high of $18.55 in June 2001. The Kentucky company was hurt by a decline in demand for communications cable.
“You would have been really sick of this stock if you had owned it then,” he said.
The buy signal for Fuller was stock purchases by General Cable insiders, including Chief Executive Gregory Kenny.
Fuller started reducing his holding in November when the stock reached $13 a share, to keep General Cable from accounting for more than 3 percent of the fund’s assets.
NetIQ’s stock has dropped to $10.94 from $109 in December 2000 as the company stacked up net losses in 16 of 17 quarters. Fuller started buying the stock in November 2003 after Chairman Charles Boesenberg added to his shares.
Even as net quarterly losses at the San Jose, Calif., company have narrowed and its cash-burn rate improved, the stock has declined since the fund bought it.
“The biases we bought it on are in play,” Fuller said. “We wouldn’t own it if we didn’t think so.”