New ETF aims to profit from the emotional mistakes of investors

Irrational investors could be opening the door to opportunity for others in a new exchange traded fund that focuses on behavioural finances in its stock selection.

Redwood Asset Management on Wednesday launched trading in the the Redwood Behavioural Opportunities Fund, an actively managed fund designed to profit from mispriced assets caused by the behavioural mistakes of other investors.

"While the study of behavioural finance is not new, Canadians have until this point not had a widely accessible vehicle to capitalize on the collective effects of investors' emotional mistakes," Peter Shippen, president and CEO of Redwood Asset Management, said in a statement.

Sub-advised by Connected Wealth, Richardson GMP's asset management division, the fund is available to investors as both an ETF - under the ticker BHAV - and a mutual fund. Management fees for the ETF and Series F fund is 1 per cent, while the Series A fund is 2 per cent.

"Investors' emotional mistakes are potentially one of the greatest sources of mispriced assets in the market, and this actively managed, multi-approach strategy is a logical way to target – and profit from – the behaviours that cause the mispricing," says Craig Basinger, chief investment officer at RGMP.

The fund is comprised of multiple investment strategies targeted towards behavioural biases or market inefficiencies, including companies that move from unloved to less unloved, earnings overreaction, indexing bias, neglect, and crowded trades. Currently, there is no public back testing available.

For example, in "loved to unloved," companies with few buy ratings tend to be neglected and beaten down, says Mr. Basinger, who is also the lead portfolio manager of the fund. "This long-only strategy is triggered by an unloved company receiving some upgrades and becoming less unloved. These companies historically have outperformed those companies with more buy recommendation."

In the 'neglect' strategy, the fund looks at how investors treat mental accounting and how they treat small spin offs, which are discarded by portfolio managers as the positions are too small to matter, add Mr. Basinger. "This creates temporary selling pressure, which this strategy takes advantage of. This is usually a long strategy."

Companies within the fund include:

* Electric utility Pacific Gas and Electric Co., which cancelled its dividend and has potential liability for October's wildfires in Northern California.

* Fastenal Co., a distributor of industrial and construction supplies, is bucketed into an "earnings overreaction" category. The company narrowly missed earnings estimates in its most recent quarter.

- TransAlta Renewables Inc., a company that was "unloved" for seven months and saw its share price beaten down and volumes depressed, but is now starting to see some analyst upgrades.

"As long as investors continue to make emotional mistakes, there will be lots of opportunity," says Basinger.