Third Quarter 2018 Client Letter


Strong corporate profits pushed equity returns higher during the third quarter of the year.  In response to strong growth and the first hint of inflation in many years, the Fed continued to increase short-term interest rates.


The annual return for 90-day U.S. Treasury bills topped two-percent for the first time in many years.  This increase helped push your money-market investments, which are closely correlated  to short-term yields, into a real return environment.  Read on to see what we are doing to improve the yield on your short-term holdings, giving you a treat not a trick.


For the last eight years our main task in managing portfolios has been allocating assets, selecting investments and watching the market.  When thinking about assets during that period, we focused on the first two of the three classes:  Equities and fixed-income, not the third, which is cash equivalents.


Managing cash was an afterthought.  And the reason was that with cash yielding less than one-half of one percent, there was little to do to increase its yield.  Once the Federal Reserve changed from their ultra-low short-term interest policy last year, cash became a viable asset class once again.


Earlier this year your custodian, Charles Schwab, altered their policy on excess cash in your account.  Schwab, as have other custodians, stopped offering customers the automatic sweep of cash into money-market mutual funds.  Instead, they switched to moving cash to their affiliated bank’s own sweep feature.  Bank sweep accounts offer a pitiful interest rate of less than one-half of one percent versus sweep money-market accounts, which yield approximately 1.85 percent.


So that may help explain why, over the last few months, you may have noticed that we have been purchasing either the Schwab Value Advantage Money Market Account, short-term U.S. Treasuries or Certificates of Deposit.  Now when we sell a security from your account, we must manually purchase shares in Schwab Value Advantage.  And the opposite happens when we purchase a security for you.  We are required to liquidate enough shares to equal the amount needed to pay for that asset.


Now you may be asking why this has occurred.  Part of it is attributable to changes that the Fed made to the type of investments that could be held in a sweep account.  But I believe that the real reason is that when discount brokers, such as Schwab, have reduced the commissions that they charge for transactions ($4.95 versus $19.95 a few years ago), they need to find revenue sources to replace them.  Brokerage firms have indicated that as much as 25% of their earnings have come from what they earned from customer cash balances.  It is not unusual for brokerage firms to earn over one percent annually for themselves on you ultrashort-term cash (trick or treat?) Now we must manage your cash balances within this new monetary environment.