New York (HedgeCo.Net) – Pawleys Capital Management is a Registered Investment Advisor based in Pawleys Island, South Carolina, just outside Charleston. They currently offer the Pawleys Growth Fund and the Pawleys Dividend Fund. We recently had the opportunity to speak with CEO and Portfolio Manager Kathryn Schwartz about her background, her investment approach and her outlook for the market.

HedgeCoVest: If you would, please tell us a little about your background in the investment industry.

Kathryn Schwartz: I started out with Dean Witter back in the early ‘90s as an advisor.  From there I moved to Charles Schwab where I held several positions. I was on a bond trading desk for several years and learned a lot while I was there.

HedgeCoVest: How would you describe your investment approach?

KS: I apply the same philosophy to both the Growth Fund and the Dividend Fund. The funds are long biased and in fact are long only at this time. The selection process for the stocks in the portfolio has been systematized. It was important to me to deliver consistent performance, and thus the reason I developed the system. I look at the ten main sectors, looking for the best stocks in each sector and then weighting the portfolios accordingly with the sectors.

I look at debt to equity ratios, earnings growth, cash flow and then some additional valuation metrics. Finally, I look at the value of the brand of the company. After I accumulate the data, I weight the different categories differently for each sector. For example, you don’t expect a tech company to have a high debt to equity ratio while an industrial company is expected to have a higher debt to equity ratio.

HedgeCoVest: It sounds like you focus primarily on fundamental analysis, do you use technical analysis at all?

KS: I do use some technical indicators, but it is not a systematic approach the way the fundamental analysis is. I will look at the chart to see if a stock is overbought or oversold before taking it out of the portfolio or even adding it to the portfolio.

HedgeCoVest: What would you say differentiates you and your funds from the rest of the hedge fund world?

KS: I think that my experience is one of the biggest things. I worked on a team at Schwab the developed Schwab’s approach to portfolio analysis and construction. When I started my company in 2010, I implemented part of that approach. The biggest thing is that I look at the numbers first—the debt to equity ratios, the earnings growth. And I do that without looking at the name of the company so that I don’t have a bias one way or the other. I want the numbers to speak for themselves and represent the stock, not the name of the company. Once I have found a few stocks that meet my criteria then I look at the name of the company. This really takes the emotion and any bias out of the selection process.

When I was at Schwab, I led a team of brokers for the active trader side of the business. Seeing what investors were doing and how they reacted, it taught me as much about what not to do as it did about what to do.

HedgeCoVest: What would you say are the strengths of your strategy?

KS: The systematic approach and the fact that I focus on quality companies with low debt and great earnings growth. The valuations are not based on forward PE ratios, they are based on the actual performance to date. I have a very low turnover in the portfolio and therefore I really have to buy quality names.

HedgeCoVest: What are the weaknesses to the approach?

KS: I would like to figure out a way to avoid or minimize the big losing trades.

HedgeCoVest: As a long only fund or a long-biased fund, is it concerning that the market is on an extended bullish run?

KS: When I originally designed the funds, I designed them as long-only equity funds, but they were designed to fulfill the domestic equity side of an overall diversified portfolio. I watch the economy and when you look at certain indicators you get a pretty good idea when the next recession or bear market is coming. If these indicators start suggesting a recession is coming, I will take action to protect the portfolios. I will probably change the definition of the growth fund to a long-biased fund at that time.

HedgeCoVest: As a long-only fund, what steps can you take to protect against an extended downturn?

KS: There are multiple ways to protect the portfolios during a downturn. I can either increase cash, buy equity index puts or use inverse ETFs or a combination of the three. It all depends on how the economic indicators look and what they are suggesting is going to happen in the months or years ahead. Even without using leverage or margin, there are still ways to protect the portfolios.

HedgeCoVest: Is there a type of market where you feel like your strategy outperforms other investment approaches?

KS: I feel that it does better when the market is down slightly or even during a period of average performance. Because I am focused on such quality companies, they tend to hold up better in a down market and perform better when the overall market is just getting an average return. It is interesting that because of the approach that I use, there have been four companies in the portfolio that have been bought out while in the portfolio. Apparently the things I find attractive in investments are also attractive to competitors and private equity firms and thus the reason they are interested in buying them. With the small number of holdings I keep in the portfolios, having four companies receive buyout offers in the four years seems to be highly improbable.

HedgeCoVest: How many stocks do you typically keep in the portfolios?

KS: In the growth portfolio, I like to keep between 20 and 25 stocks in there and with the dividend fund it is typically in the 10 to 12 range. I like to keep the portfolios somewhat concentrated and not have them too watered down.  In the Growth portfolio the allocations tend to run in the three to six percent range and in the Dividend portfolio the allocations tend to run in the five to ten percent range.

HedgeCoVest: What is your average holding period for the stocks in the portfolio and how often is the portfolio rolled over?

KS: The average holding period is 12 months, maybe even a little higher than that. As far as turnover, I would say 20 to 25% of the portfolio is rolled over from year to year. It all boils down to whether the stocks still meet my criteria or if there are better alternatives within the sector.

HedgeCoVest: We talked a little about watching the economy before. Which indicators do you look at in particular?

KS: I watch the leading indicators report and the shape of the yield curve like a hawk. I feel these give you the biggest advantage on whether or not we are heading into a recessionary period. Last year was an interesting year as 2014 saw the yield curve move toward flattening, but it isn’t flat at this point. The long-end of the debt cycle saw yields fall while the short-end yields were relatively stable.

HedgeCoVest: Since you watch the yield curve so closely, what do you see happening with interest rates and what impact do you see that having on the stock market?

KS: Initially there may be a knee-jerk negative reaction when the Fed finally acts, but traditionally a rising interest rate environment is very healthy for the stock market. It is a sign that the economy is healthy and that consumers have the confidence to spend a little more freely. After the last recession, it has taken some time for consumers to gain back the confidence they were showing in both the economy and the stock market.

HedgeCoVest: One final question for you. What was it about HedgeCoVest that led you to sign up?

KS: Once I heard what you guys were doing, I was excited about joining. I felt like it was something new and innovative and I wanted to be part of it. I have also been impressed with the professionalism of everyone I have dealt with at HedgeCoVest. But when you look at the idea and you see how you can offer the transparency that investors want, the straight forward fees and the performance possibilities, it just made sense. It is also a new channel for investors to discover my funds and the strategies I employ.

HedgeCoVest: Thank you for taking the time to speak with us Katy. We are happy to have Pawleys Capital Management on board with us.