SAN MATEO, Calif. -- The long-awaited behavioral capital asset pricing model has arrived.
Well, not quite.
But a leading academic proponent of behavioral finance, Richard H. Thaler, soon will make his own arrival in the investment business. He will become a major owner of a money management firm, taking an active role in investment strategy and marketing to prospective clients.
Mr. Thaler, professor of behavioral science and economics at the University of Chicago's Graduate School of Business, will join Russell J. Fuller to create Fuller & Thaler Asset Management Inc., offering a broad line of behavioral-based investment strategies to pension funds and other institutions.
Mr. Thaler will be the second-largest owner of the company, after Mr. Fuller. The share of ownership wasn't disclosed.
The new firm is evolving from R J F Asset Management Inc., San Mateo, Calif., which is now solely owned by Mr. Fuller. R J F manages $330 million in two basic behavioral investment strategies. Institutional investors account for 99% of its money under management, Mr. Fuller said.
Pension fund clients include Precision Castparts Corp., Portland, Ore.; and New York State Common Retirement Fund, Albany.
The $7 billion Ohio School Employees' Retirement System, Columbus, hired R J F in October, assigning $40 million for its small-cap strategy, according to Thomas R. Anderson, the pension fund's executive director.
R J F will be renamed Fuller & Thaler, take on a couple of other new principals and assume R J F's assets under management.
It will continue to be based in San Mateo. Mr. Thaler will devote much of his non-academic time to the new firm, working a lot via e-mail. He will be a principal of the firm. "He didn't want a title," Mr. Fuller said.
Mr. Thaler plans to continue his academic duties at the University of Chicago, where he is also the director of its Center for Decision Research.
Among his money management duties, he will get involved in marketing the firm's investment products.
Mr. Thaler had served as a consultant to R J F since its founding in 1992 and helped develop its investment strategies.
As a principal, Mr. Thaler said he'll be doing "everything but picking stocks" at Fuller & Thaler.
"What Russ has been doing is trying to implement strategies based on research in psychology and behavioral finance I've been contributing to," he said.
Explaining why he is becoming a money management firm owner now, Mr. Thaler said, "It seemed right from both ends."
"The firm is now big enough that people can take it seriously, and it has a track record." Indeed, Mr. Fuller said, the assets under management grew to $330 million now from $130 million at the beginning of this year.
At the university, his academic work is more stable. "I came to the University of Chicago three years ago. There were a lot of things to get done and to get the group I'm in charge of humming."
Mr. Thaler becomes the latest financial academic to enter the money management business while remaining on a faculty. Among investment management firms with academics is one that happens to use some behavioral ideas in its investment process, LSV Asset Management, Chicago. It is named after the initials of its three academic principals: Josef Lakonishok, professor of finance, University of Illinois, Champaign; Andrei Schleifer, professor of finance, Harvard University, Cambridge, Mass.; and Robert W. Vishny, professor of finance, University of Chicago.
"If I stop doing academic research, my value to the firm and the university will decline. So my incentives are lined up," Mr. Thaler said.
Mr. Fuller himself was chairman of the finance department of Washington State University, Pullman, before leaving to join the now-defunct Concord Capital Management in 1990. He formed R J F in 1992.
CLIENTS LAUD CHANGE
Institutional clients of R J F were delighted by Mr. Thaler's decision to join Mr. Fuller.
"This guy's a genius," said Mark P. Hurley, president and chief executive officer, Undiscovered Managers LLC, Dallas, referring to Mr. Thaler.
The firm, a client, seeks out small managers with outstanding performance and ERISA clients, to set up and market institutional mutual funds for them. It set up and markets R J F's only mutual fund and plans to set up and introduce two more mutual funds managed for the firm by the end of the year. All three will be managed by Fuller & Thaler.
"Thaler is like having an Olympic athlete or like having a Michael Jordan on your team," Mr. Hurley said.
Messrs. Fuller and Thaler work in the microbehavioral area to develop a stock-picking strategy.
In the cognitive area, they try to understand how the brain works, how people make mental mistakes in making investment decisions.
NEW STRATEGY IN WORKS
The firm, now strictly in small-capitalization stocks, is working on a large-cap strategy. But Messrs. Thaler and Fuller expect it could take well into next year to develop it.
Among other new products, it hopes to set up an offshore version of long-short strategy by January for ERISA funds, to avoid being subjected to unrelated business income tax.
It also hopes to pursue 401(k) business and is close to landing two such clients, including a well-known company, Mr. Fuller said.
Its small-cap growth strategy has the most assets under management, $190 million, including $16 million in the mutual fund. From its inception in January 1992 through last Oct. 31, it has returned an average annualized 24%, compared with the Russell 2500 growth benchmark of 9.1%.
It exploits a behavioral bias people tend to have: under-reaction to financial information.
"We know from psychological literature that when people make estimates, they are guilty of anchoring," that is, not expecting major changes, Mr. Thaler said.
The small-cap value strategy has $130 million under management. From inception in January 1996 through last Oct. 31, it has returned an average annualized 16.2%, compared with the Russell 2000 value benchmark of 13%.
It also has a $12 million long-short strategy, which is not leveraged and not market-neutral. The strategy returned 24.3% in 1997 and 13.8% year to date in 1998 through Oct. 31.
The long side is a composite of the firm's growth and value strategies, while the short side is the mirror of the value strategy. The total portfolio tends to have a net long position ranging from about 10% to 30%. The long position typically is 90% of the portfolio, while the short position is 70%.