Rough start to 2008

The Scout Partners Index of Western Colorado stocks fell -4.59% while the broad market fell -6.01% in January (total return including dividends). The 25 stock index focuses on large companies whose operations have a significant impact in Western Colorado. It includes major Mesa County employers such as Wal-Mart, Halliburton, Kroger (City Market), Exxon Mobil, StarTek, CRH (United Companies), and the Union Pacific Railroad.

Energy stocks fell more than the market as falling crude oil prices marked the beginning of the new year. The leader in December was Wells Fargo Bank (WFC), which rose +12.9% during the month to close at $34.08. The bank reported solid revenue growth and no unexpected loan reserves for the most recent quarter, and rallied with the rest of the financial sector when the Federal Reserve dramatically lowered short-term interest rates to 3.0% in the latter part of the month.

Doug May, President of Scout Partners, a Grand Junction-based registered investment advisor, noted that, "Wells Fargo hasn't strayed into areas of investment banking and deal-making that got Citigroup and some other banks in hot water,” May said. "They warehouse much of their own loan production, too, which kept them focused on loan quality while other financial companies became too preoccupied with the quantity of loans underwritten." Loan losses associated with foreclosures of sub-prime loans have forced several other financial service firms to additional capital to shore up their financial position, but Wells Fargo has thus far avoided those difficulties.

Qwest (Q) was the worst performer in the index for the second month in a row, falling -16.0% in January. The stock closed the month at $7.01. AT&T helped trigger the mid-month sell-off in stocks when the company's CEO cited consumer softness at an investor conference on January 8 that was broadcast over the web. During the month, the telecom sector fell -12%.

"Qwest was hit a bit harder," May observed, "because it is more leveraged and therefore more at risk if we do find ourselves in the midst of a major recession."

Scout Partners equal weighted index of Western Colorado Stocks is comprised of 25 stocks that hope to reflect, to some degree, business conditions in Western Colorado. Reflecting the local economy, the index has a large (over 30%) concentration in the energy sector, which tends to drive index performance. The next largest sector concentration is in Industrial stocks, which comprise over 20% of the portfolio. Local stocks are up +4.7%% over the past 12 months while the overall market has returned -2.32% over the same time period.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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The Fund Supermarket innovation

In 1990, discount broker Charles Schwab introduced a new product aimed at offering its mutual fund investors the ultimate in investing convenience. It named its new product "OneSource" because it offered mutual fund investors an account through which a number of different no-load mutual funds could be purchased, with the added convenience of having to remember only one telephone number, and the ability to keep track of them on one, single account statement. Charles Schwab called its new product a no-load mutual fund supermarket. It was a hit.


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The fund supermarket approach was quickly copied by Jack White, a San Diego-based discount brokerage house that was purchased by Toronto Dominion Bank, re-christened TD Waterhouse, and eventually merged with internet upstart Ameritrade to become TD Ameritrade. The internet era also birthed E-Trade, and Fidelity Investments launched its own platform. Billions of dollars began flowing into these supermarkets. Professional investment advisors, many of them ex-brokers and financial planners, transferred client investments onto the OneSource platform. Huge sums of money have flowed into mutual funds associated with Schwab's supermarket and in 2007 the company holds $1.5 trillion in client assets in its custody. Fidelity Investments, one of the largest mutual fund managers in the world with its own $1.5 trillion in managed assets, also custodies an additional $1.8 trillion in its custody accounts, roughly equal to all the Merrill Lynch client assets in the world.


Schwab's innovation changed the face of the financial industry. It qualifies as one of the most important improvements in financial technology of this century.


Prior to Schwab's invention, do-it-yourself retail investors selected various no-load funds based on their own research and then had to contact each fund, separately, to open accounts with each of the different fund families. The larger funds families were able to offer investors a sort of "company store" approach, where transfers between funds were easily implemented, so long as investors stayed within the family. But Schwab recognized the firm could add value by making it possible for investors to invest in various funds, from several different families, in a single account. Investors could keep track of purchases, sales, and portfolio holdings on one consolidated statement. Schwab also realized that such a marketplace would offer advantages to vendors, as well, who would pay for the privilege of offering their wares.


Tom Seip was manager of Schwab's retail investment network at the time. He still remembers the point at which he realized that the fund supermarket was a radical idea that had the potential to transform the financial services industry. He and another Schwab executive had been asked to make a presentation on their new OneSource baby to Barton Biggs. Biggs was the Chief of Asset Management for Morgan Stanley, one of Wall Street's premier institutional brokerage firms. After listening to their presentation, Biggs is said to have told them, "its time for me to retire because this program will change the world of mutual funds as I know it." With the new product, "investment management becomes the commodity," Biggs observed. He recognized that the economic power would inevitably shift away from Wall Street (the manufacturers), toward the distribution channel, and eventually end up in the hands of consumers.


Full-service brokers were forced to completely revamp their own fee structures, moving away from trading commissions toward fees based on assets under management. As Barton Biggs predicted, the entire industry is being restructured to compete with this new financial upstart. In 2006, the Luxury Institute released a customer experience survey of 11 leading brokerage brands, including A.G. Edwards, Ameriprise Financial, Charles Schwab, Edward D. Jones, Fidelity Investments, Merrill Lynch, Smith Barney, TD Waterhouse, UBS Financial (we used to know them as Paine Webber), Wachovia Securities and Wells Fargo Investments. The institute, an independent, objective research institution focused on ranking luxury brands, surveyed 2,100 households with a minimum of $200,000 in gross annual income and net worth of at least $750,000 (the median net worth was $2 million). Of the 11 firms, Fidelity led the list, followed closely by TD Waterhouse (the next year’s survey winner) and Charles Schwab, while traditional Wall Street firms like Merrill Lynch and UBS joined the bank sponsored investments firms at the bottom of the survey. The world is changing. Hundreds of millions of Wall Street advertising dollars can only slow the rate of change, not alter the ultimate course of the evolution.


Next post: Most Local Advisors Can't Compete


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Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

Go to Investments main page.