Our funds target stocks that are either underreacting to good news or overreacting to bad news. The Fuller & Thaler Behavioral Small-Cap Growth Fund (FTXSX) is in the first category. Instead of looking for stocks that are about to move higher, we want companies that are already rising because of developments like strong earnings or new products but have much further to go.
We are actually buying the news of the positive information and we're actually selling it when the analysts or the market participants have caught up to that news or new information about the company.
The key to that is finding stocks where analysts are too slow to update their estimates and opinions once that good news arrives. That makes them "biased forecasters," and it can be a sign of opportunity in the stock. If expectations are stubbornly low, the company should beat them repeatedly, leading to long-term gains.
The next quarter, you are going to see a positive earnings surprise, or sales surprise. And this will go on for a number of quarters until the analysts actually catch up.
Hortz: Is there anything particularly timely about the small-cap area at this juncture?
Stanske: As you know, although small-cap stocks have historically outperformed large-cap stocks by a significant margin, small-cap stocks have underperformed large-caps for a while now: the Russell 2000 index has returned 8.25% in the last five years vs. 13.67% for the S&P500. If one expects small caps to eventually revert to their pattern of outperforming their larger-cap peers, then investing in them now, after this long period of underperformance, would be a good idea.
In the near term, small caps have underperformed large caps partly because investors have sought the safer havens of established large-cap companies whose business have been less affected by the pandemic and are viewed as likely to survive the pandemic. If you believe that the market will eventually anticipate the end of the pandemic and the start of a global economic recovery, it would not be unreasonable to expect small-caps to outperform in such a market environment. If we look back over the last 15 recessions since 1926, a recent study by Jefferies found that small-cap stocks have outperformed large caps by 3.9% in the second half of a recession and by 15.8% in the year following a recession (Source: Center for Research in Security Prices (CRSP®), The University of Chicago Booth School of Business; Jefferies). We think it is a great time for investors to consider rebalancing their portfolios, which naturally means selling things like large cap growth and FAANG stocks that have gone up the most and investing in smaller cap stocks that still represent potentially better value.
Hortz: Any final advice on how you would recommend advisors employ behavioral finance and your funds for their client portfolios?
Stanske: The most common piece of feedback we receive from investors is that Fuller & Thaler’s investment approach is unique and significantly different from the fundamental and quantitative approaches used by other managers. For investors looking for a manager whose investment methodology complements those of their other investment strategies and whose investment track record shows substantial long-term alpha across several investment strategies, Fuller & Thaler could be an ideal choice.
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