(February 21) – “Investors often behave irrationally: buying high, selling low, holding on to dud stocks for sentimental reasons,” writes Sarah McBride in today’s Wall Street Journal.

“ABN Amro Holding NV’s ABN Amro Asset Management thinks it has found a way for investors to make money from those poor decisions. Following in the footsteps of some funds in the U.S. and Europe, it launched its Japan Behavioral Finance Fund in Asia last week.”

“The funds work by anticipating irrational investor behavior, and investing accordingly. Although there is a lot of irrational investing out there, overreaction and underreaction to news provide two common opportunities.”

“For example, Philip Morris Cos., the giant tobacco and food company, announced lower-than-expected earnings Jan. 31. The reason: It unexpectedly included a $50 million interest charge related to its acquisition of Nabisco Holdings Inc. That day, the stock dropped 91 cents to $44 but rebounded the next day to $45.79, providing an opportunity for profit from the initial overreaction.”

“In other situations, investors are slow to react. Take H.J. Heinz Co., caught in a food-industry slump from the beginning of 1999 that almost halved its stock price to just above $30 by the beginning of 2000.”

“Heinz announced a series of restructuring plans, and by the end of 1999, announced earnings slightly higher than expected. Analysts were skeptical; some downgraded the company at year end, and its stock price kept falling. But Heinz again announced slightly better-than-expected earnings the next quarter. By the following earnings announcement, in June 2000, expectations finally had caught up with reality. Heinz ended the year at $47.44.”

“Both overreaction to unexpected news and underreaction to long-term changes are very common, say behavioral-finance scholars. Fund managers are using the behavior to try to make money, by buying quickly after positive earnings surprises, for example, before people adjust their expectations and drive the price up.”

“Although likely to be much more volatile, the concept bears similarities to value investing, when managers buy out-of-favor stocks at low prices. However, behavioral-finance fund managers don’t necessarily have to believe the fundamental characteristics of a stock are good; they just have to think that it will go up in price.”

“Patrick Ko, manager of ABN Amro’s Behavioral Finance Japan Fund, is confident he can use the emotions of others to earn money for his fund holders. And just to make sure he doesn’t get too emotional himself, he relies on computer models. When his computer spits out a recommendation, he buys or sells, regardless of what his gut feelings tell him.”