20 September 2019
Richard Thaler, this year's winner of the Nobel Prize for economics, established a fund that has far outperformed the S&P 500 in recent years. Photo: Reuters
Richard Thaler, this year's winner of the Nobel Prize for economics, established a fund that has far outperformed the S&P 500 in recent years. Photo: Reuters

Nobel Prize winner Richard Thaler walks the talk

Many have viewed economists as individuals who live in ivory towers, spouting ideas and theories that may not work in real life. Richard Thaler, this year’s winner of the Nobel Prize for economics, is definitely an exception.

A pioneer in behavioral economics, Thaler has established his own fund to invest in small-cap stocks, and its performance over past eight years has been remarkable, far outperforming the S&P 500 index.

Behavioral economics, a branch of microeconomics, is based on the presumption that everyone is rational, provided that all other factors remain unchanged, all information are transparent and market operates efficiently. As such, economic theories may not fit well with ever-changing, real-life circumstances.

So behavioral economics studies the effects of psychological, social, cognitive, and emotional factors on economic decisions.

Thaler, 72,  has written several books on the subject, including Quasi-rational Economics, The Winner’s Curse, and Misbehaving: The Making of Behavioral Economics.

He is widely recognized as one of the founding fathers of “nudge” theory, and his works explored mental quirks such as loss aversion and the status-quo bias. Many in the field believe that Thaler’s award has been long overdue.

A professor of the University of Chicago, Thaler is the principal of Fuller & Thaler Asset Management Inc. The firm, founded in 1993, advises on funds, including the Undiscovered Managers Behavioral Value Fund.

The flagship fund, which focuses on US small-cap equities, has gained over 480 percent since 2009, while S&P 500 has risen 250 percent over the same period.

Thaler once shared his investment tips, which is to take advantage of the cognitive bias of public investors.

Investors usually get over-optimistic in good times, but over-pessimistic in bad times. As a result, some stock prices may soar or slump so much that their prices could deviate a lot from fundamentals, and such situations provide good trading opportunities for Thaler.

In fact, the company has posted a motto on its website that reads, “Investors make mistakes. We look for them.”

Benjamin Graham, a pioneer of value investment, has a similar theory. He created a guy called Mr. Market. Mr. Market is a fellow who turns up every day at the stockholder’s door offering to buy or sell his shares at different prices. In most cases, his quoted price is reasonable but not worth trading. Sometimes, Mr. Market offers irrational prices, which provide the best trading opportunity.

“There are two kinds of mistakes that produce buying opportunities: over-reaction and under-reaction,” Fuller & Thaler said on its website.

For instance, in a bear market, a little-known small-cap stock may not rise much even though there are major positive developments regarding its fundamentals. As the share price under-reacts, Thaler would put a heavy bet the stock.

The entry threshold for his fund is about US$3 million. Also, the fund is not open to the public; it only accepts investors who share its investment philosophy.

This article appeared in the Hong Kong Economic Journal on Oct. 11

Translation by Julie Zhu with additional reporting

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Hong Kong Economic Journal columnist