Schwab hedge bet leverages advice

Charles Schwab Corp.’s move into hedging strategies signals more than a continuation of its risky transition from plain-vanilla discount broker to sophisticated full-service company.

Last week’s launch of the Schwab Hedged Equity Fund – along with the recently launched Core Equity Fund – is part of an aggressive new effort to make homespun advice the linchpin of the company’s future.

In a separate announcement last week, Schwab reinforced the importance of its move into proprietary mutual funds. It appointed Randall Merk to oversee all aspects of Charles Schwab Investment Management Inc. as its president.

Mr. Merk is the former president and chief investment officer of American Century Investment Management Inc. in Kansas City, Mo., which has $75 billion under management.

Charles Schwab Investment Management already is the nation’s 11th-largest mutual fund company.

But the profitability and sexiness of that subsidiary’s offerings are limited. Until now, Schwab had subcontracted its actively managed equity funds to outside advisers. All of its internally managed funds are index, bond or money market funds.

Hedged Equity will be a Schwab product from start to finish, and it will generate a hefty 2% management fee. Three portfolio managers in Schwab’s employ manage that fund.

Schwab executives have decided to step across the advice line because of the company’s’ recently launched equity-grading system.

The proprietary system, which rates stocks on an A-F scale, provides the objective input necessary to create funds.

The Hedged Equity Fund’s managers can short stocks primarily with a D or F rating. They can go long on stocks only with A and B – and on rare occasions C – ratings as they make their stock picks. Its long-to-short ratio is set at 4-to-1.

The moves come at a time when Schwab, reeling from a dismal July, is signaling its intention to lay off more employees.

Schwab executives expressed their shifting corporate outlook in a memo to employees – first published by The Wall Street Journal.

“The recent series of sharp declines in the market, augmented by continuing corporate accounting and governance breakdowns, have deepened our belief that the environment in which we operate has fundamentally changed,” the memo states.

“We feel the damage to investors’ confidence has been extensive and that the pressure we face on our revenues is likely to continue for some time.”

Still, the Schwab Hedged Equity Fund reflects some optimism.