Mr. Potter: Fuller & Thaler was started in 1992 by Russ Fuller and has strong ties to the academic community. Russ Fuller was previously a professor of finance, and the other principal, Richard Thaler, is a noted behavioral economist from The University of Chicago. The firm was founded on the principles of behavioral economics which essentially means that at times people act somewhat irrationally and there is potentially a way to take advantage of this in the investment markets.
Continuing along the academic ties, we have Daniel Kahneman, who won the Nobel Prize for Economics back in 2002, on our Board. We are also fortunate to have an Academic Advisory Board which includes four of the most distinguished scholars in this area as well. It's quite deeply rooted in academics and we are trying to bring that academic knowledge to the practical aspect of managing money.
In terms of what I do here, I manage the small cap value strategy and that was started in January, 1996. It's been almost 14 years now since the small cap value product was launched and it's achieved annualized gains of approximately 13% prior to fees through September 30, 2009 (about 12% after fees) versus its benchmark (Russell 2000 Value) at 8.7%, so an outperformance of over 3% per year.
TWST: What is your definition of value? Tell us about the portfolio that you are responsible for and the criteria that you look for in potential holdings.
Mr. Potter: We define value rather broadly, but in a specific sense, we look quite closely at price-to-book in terms of a portfolio metric. When we aggregate the portfolio we won't be too far above or below the benchmark metric. Our clients will look at that quite closely too to make sure that there isn't a lot of style drift. The way we look at choosing stocks, however, is not based on P/B - that's more of a check at the portfolio level. The way we look at choosing stocks is a three-pronged process. The first part is the behavioral screen, which is essentially looking for overreaction in certain company stock prices usually in regards to past negative news announcements or general industry malaise and we overlay that with a screen for insider buying and/or share repurchases (the second part); our philosophy is that few people will know more about the company's prospects than corporate insiders such as the CEO, CFO or potentially some of the directors on the Board and so when we see some of these people buying significant amounts of their own stock that raises an interesting signal to us.
The third prong which obviously I spend most of my time on is the fundamental analysis of these companies. In general it tends to be a bit of a contrarian style strategy in that our primary signal is driven by insider buying. Those insider buyers tend to be highly contrarian in nature.
In the last year or so as we've seen tremendous volatility, the insiders have actually been quite prescient in their buying. They were buying in droves in November of 2008 and also in February and March of 2009 this year when the market last reached its nadir. However, to alleviate the risk of catching any proverbial falling knives, we do overlay this, as I previously mentioned, with a significant amount of our own fundamental analysis.
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