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Lakeview Investment Advisors, LLC

Commentary Date: Fall Interim 2003

by Bill Westhoff, CFA

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Lake Views

Lakeview Update

Lakeview has completed its first year in business and celebrated the occasion with a party for Minneapolis clients and friends on November 19, 2003. Dr. Bill Melton was the keynote speaker and provided an upbeat assessment of the US economy, coupled with a positive outlook for stocks through 2004. This meeting also gave me an opportunity to share learnings from the Schwab Institutional Conference held in San Francisco from November 11–14. Below is a summary of some of the sessions that I attended.

Schwab Conference

Regaining Transaction; Daniel Leemon, EVP and Chief Strategy Officer, Schwab:

The speaker reviewed the role of Investment Advisors (IAs) in the Schwab business plan and the current climate, which includes: Confused Investors, Relentless Competitors, and Excellent Opportunities for Investment Advisors. As people age and/or gain more wealth, their desire for investment advice increases. Schwab sees excellent demographics supporting the investment advisory business over the next 25 years. The percentage of the US population under age 60 who will reach age 60 will be 9% in 2003–08, 14% in 2009–18, and peaking at 16% in 2019–28.

As evidence that IAs are meeting a growing need, assets managed by IAs held flat at $1.3 trillion from 2001–02, while total investable assets declined by 7% and the S&P 500 Index declined by 23%. When individuals are polled for what they want in wealth and money management, they desire: transparent pricing, no conflicts, experienced advice, choices, a broad range of options, customization for their needs, a high service relationship, independent research, benchmarked reporting, a portfolio management focus, local presence, and community involvement.

Investment Advisors have differentiated advantages over Banks & Trust companies, Discount Brokers, and Traditional Brokers.

The Future of the Financial Advisory Business; Robert Worthington, Undiscovered Managers

The speaker’s key points: Competition is increasing and the Investment Advisory business is evolving. The business will likely consolidate over the next several years. This is a natural evolution in a free-market system in a business where demand for service is greater than supply, where there are low barriers to entry and relatively low capital requirements, and where profit margins are relatively high and the business produces recurring revenues. The likely evolution is to: dominant competitors (large and profitable), niche competitors (small to mid-sized with a perceived expertise in specific areas), and small firms (marginally profitable with little value as a business).

Lakeview’s strategy is to remain as a smaller, niche firm, focused on its perceived (?/actual) expertise in portfolio management.

Geo-Political Risk and Perspective; Karen Elliot House, Publisher, Wall Street Journal

The bad news: we live in difficult times. The good news: the present administration and most of the American public are facing up to the challenge.

The period from 1949–89 was the Cold War, where the US and its allies triumphed over communism by a persistent pursuit of the principles of democracy and free markets. 1989–01 was a period of transition where the free world did not understand terrorism or pursue it adequately. From 9/11/01 it is a new era. This period is like the Cold War; taking decades and a continual struggle to defeat. The US population has little patience for long struggles.

Several quotes are worth passing on because her training as a journalist is clearly evident in her choice of words. “Terrorism is a hydra-headed monster; dialogue with a demagogue is not a solution. The sad truth is, there is evil in this world, and the only way to deal with it is to confront it and not compromise with it. Iraq—we have gone to fight terrorists on their soil with trained soldiers, rather than in US cities and office employees.”

Open Forum; David Pottruck, CEO Chas. Schwab and Craig Barrett, CEO Intel.

This was a wide-ranging discussion of leadership, company culture, and recovering from recession. It was interesting to see and hear their thoughts.

Some of the more interesting facts: Intel sells through 140,000 distributors world wide. In places like Russia and China, small distributors account for one-half of the computers sold. Moore’s Law is alive and well—Intel still sees a doubling of computing power every 18 months. Barrett says, “Technology change never slows down, but recession changes the amount of revenues. Can’t save your way out of a recession, but must invest your way out. Intel has invested $27 billion in capital in the last three years.”

David Pottruck says the advisor business is one of the most important at Schwab, with over 5,000 IAs representing over $200 billion of assets under management. Courage is needed to make incremental improvements in a company’s business. Regarding the financial service business, “My greatest hope is to stop stubbing our toes.”

Manage Your Investor; Dr. Meir Statman, Professor of Finance at Santa Clara University, and Jason Zwieg, Columnist at Money magazine.

This was one of the most interesting sessions, providing a deeper understanding of investors’ actions.

Statman: As physicians promote health and well being, Investment Advisors are financial physicians, promoting wealth and well being. IAs must manage investments and investors. In standard finance theory, investors are rational; in behavioral finance, investors are normal. In difficult markets, Advisors must “breathe first” when working with clients.

Zwieg: There are physiological explanations for the “fear and greed” actions of investors. Over 60 million years of primate evolution has shaped the development of our brains, where to underestimate a real risk resulted in death, but to over-react to an apparent danger means no harm is done.

The amygdala of the brain is the seat of visceral, hot responses like fear and anger and can trigger releases of adrenaline, fusing memories of negative experience and aversive emotion. The opposite reaction to fear is greed. The release of dopamine in the brain makes us feel good when we make correct predictions under conditions of risk and uncertainty. The dopamine system is more interested in reward than in punishment. Unfortunately, the brain becomes conditioned to this “rush” from the release of dopamine and starts to anticipate the reward. In market terms, market participants start to anticipate good news and start to trade up the market or individual stocks before a news release. This is known as the “prediction addition.” When there is no reward as anticipated, the early release of dopamine without the confirmation leads to depression. This explains the sometimes severe reactions seen in some stocks which miss their estimates by a penny or two.

The best way for an investor to deal with this is to act rationally. Over time, the price for a company’s shares reflect its value as a business. During periods of extreme fear or greed, price and value become unhinged, creating opportunities for investors who stay focused on the “value” of a business.

Tax-Smart Charitable Giving; Kimberly Wright-Violich, President, Schwab Fund for Charitable Giving

This session helped me understand how a charitable fund works and why a client might want to use this vehicle.

First, some interesting facts behind charitable giving: US charitable giving is 2.37–2.4% of GDP, and Great Britain is the next most-generous country at only 0.7% of GDP. Philanthropy is a big business, with $241 billion in gifts in 2002—76% coming from individual donors. Individual philanthropy supports 51% of all hospital beds, 49% of all higher education institutions, 20% of students on scholarship, 95% of orchestras and 60% of social service organizations. Bottom line: Americans are generous, supporting many worthy causes.

A charitable fund (called a donor advised fund or DAF) can facilitate this generosity by overcoming some common obstacles. People often want to give but don’t because they lack confidence that their donation will be used productively, they have not identified a passion for a cause or a connection with a charitable organization, and they often don’t have time to investigate or get involved. The DAF allows the donor to separate the tax decision from the charitable decision—providing “tax deductions when you need them and charitable donations when others need them.”

The Schwab DAF provides the following benefits:

  • Informative online services to help donors chose charities
  • The Schwab fund does the due diligence on charities
  • Gifts can be designated online
  • The fund does all the record keeping and handles the paperwork
  • The fees for this service are reasonable

How it works:

  • Client opens a charitable gift account with an initial, irrevocable contribution of cash or a security valued at $10,000 or more and receives an immediate tax benefit
  • Recommends how contributions should be invested among a range of five mutual funds
  • Builds the account with additional contributions of $500 or more when it is convenient and when it provides the greatest tax benefit
  • Recommends grants of $250 or more at any time, to any qualified public charity they chose to support
  • Leave a lasting legacy by naming successors for their account who can continue to request grants

There were several other sessions that I attended but were not unique enough to pass on. The conference also afforded the opportunity to visit with 200 vendors of mutual funds, technology providers, and sources of research. Two booths were of particular interest. Exchange Traded Funds (ETFs) appear to provide a good alternative to mutual funds. The ETFs can be traded during the day and have expense ratios much lower than actively managed mutual funds. More research is needed on my part to gain comfort with these securities and when to use them. The other fund of interest is the Grizzly Short Fund offered by Leuthold Funds. This is a 100% short fund and should provide an excellent hedge against long positions in portfolios during periods of market weakness. Currently, Lakeview has a positive assessment of the stock market, but there may be opportunities to use this fund in the future as the market continues to move up.

© 2004 Lakeview Investment Advisors, LLC

Any information provided in these materials is believed to be from reliable sources. Lakeview Investment Advisors, LLC makes no representation as to its accuracy or completeness and is not responsible for any damages incurred as a result of your use of these materials. These materials do not constitute a solicitation to sell or offer to sell investment advisory services to residents of any state in which Lakeview Investment Advisors, LLC lacks authority. Part II of Form ADV, which details the business practices, services offered, and management fees charged by Lakeview Investment Advisors, is available upon request.

The Economics and Markets Advisory Board consists of the following members:

Theodore H. Busboom, CFA, President, Prospective Value, formerly Senior Vice President and Portfolio Manager, American Express Financial Advisors

Ray S. Goodner, CFA, Private Investor, formerly Senior Vice President and Portfolio Manager, American Express Financial Advisors

William C. (Bill) Melton, PhD., President, Melton Research, Inc., formerly Chief Economist, American Express Financial Advisors

Jim Walline, CFA, President, Walline Capital Advisors, LLC, formerly Vice President and Portfolio Manager, Thrivent Financial Services

Lakeview Investment Advisors, LLC participates in a Board of Advisors consisting of professionals in the investment field; however, members of that Board who are not employees of Lakeview Investment Advisors, LLC do not participate in providing investment advisory services offered to clients.

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