Managing Yourself Well

Managing your emotions is as important, if not more important, than managing your holdings.  Late in the afternoon on Friday, October 31st, 2014, I sat and reconciled the year to date returns on the Pawleys Funds.  I tried to work quickly so I could make it to a Halloween party on time.  The Pawleys Growth Fund, through October, had posted a gross total return gain of +13.65%, versus +10.87% on the S&P 500.  That made me happy to have good numbers for my investors.  On the plus side, I had doubles for the year in Green Mountain Coffee Roasters and Questcor Pharmaceuticals, the latter of which had been bought out earlier in the year.  On the negative side, Whole Foods Market and Mitcham Industries had lost -31% and -42% respectively – nothing to write home about.

As I scanned the range of returns for the portfolio holdings, one stood out to me: Sapient Corp, a digital marketing firm based in Boston, which sat at exactly 0% for the year.  The fundamentals of the company continued to look good, but how could a nimble player in a hot space deliver a goose-egg return during a decent year in the market?  Feeling impatient, I had thought for several weeks now that there might be a better opportunity to replace this stock.  I turned off the computer, trundled off to my Halloween party, and tried to forget about it over the weekend.  Late Sunday night, my e-mail lit up with news alerts on Sapient – there was a rumored buy-out pending.  Monday morning, it was officially announced that Publicis Groupe would buy the company at $25/share, which turned my goose-egg into a +44% gain for the position overnight.  For the full year of 2014, the Pawleys Growth Fund trounced the S&P by +5.65%, helped in part by the nice gain on Sapient.  Thank goodness I had held the position.

In the 1990’s, I spent several years in management roles within financial services.  I loved the challenge of motivating and inspiring others to do well.  I remember vividly in one training class being taught that the most important aspect of managing others rested on how well you could manage yourself and your emotions.  Now I see how the same holds true as a manager of assets.  Self-managing my impatience around Sapient directly resulted in good gains for my investors last year.

© 2015 Pawleys Investment Advisors, LLC. All rights reserved.

Investors Should Worry More About Payment for Order Flow than HFT

Long gone are the days of the buttonwood tree.  On May 17th, 1792, twenty- four brokers gathered on Wall Street under a buttonwood tree and signed the document that would establish the guidelines for buying and selling stocks and bonds, and held members to adhere to a 0.25% commission rate.  Deals were done with handshakes, not high speed computers.

Buttonwood Tree from Museum of the City of NY

Wall Street Brokers Under the Sycamore Tree – Source: Museum of the City of New York

Things must have gotten a little crazy over 200 years, because by the time I started in the business at Dean Witter in the early 1990’s, we collected several hundreds of dollars in commissions for small stock trades (um, most of which the company kept, I received only about 1/4).  Then along came one of my heroes, Charles Schwab, who had railed against high fees and was instrumental in the deregulation of commissions which was mandated by the Securities and Exchange Commission in May of 1975.  The mandate eliminated high fees and allowed lower cost providers such as Schwab to force market competition to set commission rates.  By the time I was working at Schwab in 1995, online trading was launched, driving down commissions.  Technology has revolutionized the stock markets, and expanded access that was previously limited to exclusive groups.

In 2004, Schwab sold its capital markets business to UBS and, as part of that agreement, sends the majority of stock trades (known as “order flow”) to UBS.  In exchange, UBS pays Schwab.  Over 90% of orders are sent to UBS from Schwab to be fulfilled (see link below for details).  In his 2000 testimony to the Senate Banking Committee, Schwab himself stated “I worry…about payment for order flow” and went on to explain that Schwab continued the practice due to competitive pressures (see the full testimony below).  Firms like Schwab, E*Trade and TD Ameritrade bring in hundreds of millions of dollars every year from this practice, enabling them to offer low commissions to their retail customers.  The proliferation of trading drove down commissions, but forced firms to seek out revenue in other areas.

This is what enables financial firms to also offer what appear to be ridiculously low-cost Exchange Traded Funds and Index Funds.  How could a fund with expenses below 0.25% be a sustainable business model for an investment company?  Investors are paying the price elsewhere.  We may see an upheaval with respect to this, because it affects a huge aspect of the markets – the expanded ETF market and mutual funds held in 401(k) plans.  If you have investments in a 401(k), it is likely that the fees are quite high, you just don’t necessarily see that despite recent legislation to improve disclosures.

The real issue is this: how can investors truly know what they are paying so they can objectively evaluate their after cost returns on an annual basis?  This issue of excessive fees and a lack of transparency has always lit a fire under me, and led to my launching of the Pawleys Dividend Fund and Pawleys Growth Fund, two privately offered funds organized under Rule 506 of Regulation D.  My advisory fee is 0.75%, and I publish the holdings to all investors to ensure complete transparency, as any shareholder can audit the performance.

Online trading added unprecedented volumes to the stock markets, and as commissions dropped firms worked to find revenue in other places.  In the meantime, they leveraged the public loathing of high commissions and fees, and cleverly built this into their marketing of “low cost” investments.  Low cost does not equate to performance.   There are many great choices for investors that offer reasonable expenses and solid performance.  Establish a procedure where you evaluate the after-cost performance of your investments versus the appropriate benchmark.  For those who are lured by the discount broker advertisements that say you can make money trading (bumping up the commissions and payments they receive for order-flow), you can, if you learn about technical analysis and enter with a specific trading strategy.  Scalping and front-running are two practices that disadvantage investors and are prohibited (it is like someone taking money from you or cutting the line in front of you).  These practices existed long before HFT came along.

If you are truly worried about HFT and how they are rolling in the dough, take a closer look at what happened to Knight Capital.  Knight, based in New Jersey, used HFT algorithms and was the largest trader in U.S. equities until an accidentally released set of code led to the company taking a loss of almost $500 million and their downfall.  So much for HFT.

© 2014 Pawleys Investment Advisors, LLC. All rights reserved.

Schwab Order Routing:

Testimony to Senate Banking Committee:


Shark Advice from Pawleys Island

“If you’re hard on yourself, life will be easy on you.”

– Robert Herjavec