Global Risk / Global Opportunity

Ten Essential Tools for Tracking Minds, Markets & Money

Shlomo Maital and D.V.R. Seshadri

RISK

OPPORTUNITY

What are your goals?

What are your expectations in working through this book?

When youve finished reading it, how will you know if your time has been well invested?

6 Objectives of Global Risk/Global Opportunity

To understand what it means to think and act like a global manager, with a true global perspective To learn how analyze global risk and always relate to global risk as a form of concrete business opportunity To build a set of useful clearly understandable tools that will enable managers to assess and track global risk with accuracy, systemically
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 To enhance skills in analyzing a new market or country or geography, as an initial key step in doing business in that country To constantly sharpen risk-analysis skills by engaging in action-learning exercises that apply the 10 essential tools to analysis of risk in a new and perhaps unfamiliar country or in a familiar country where new insights are sought. To understand how global risk can be analyzed, assessed and causally understood, in ways that offer insights into likely future scenarios.
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The Structure of this Book: Chapters One To Five

Chapter One. Global Crisis 2007-2009: Causes & Opportunities
This chapter explains the nature and origins of the global capital market crisis that began in the United States in 2007 (as the so-called subprime mortgage crisis) and spread elsewhere.

Chapter Two What Is Your Story? How to Build Powerful Global Narratives
This chapter helps you understand why it is vital for managers to acquire their own macroeconomic analytic tools 5 and develop their own perspective on key trends in global markets.

Chapter Three Risk Management with Telescopes & Microscopes

This chapter explains that managers need a peculiar type of vision -- one that enables them, with one eye, to zoom out on global events and to tracking minds markets and money all over the world (telescope) and with another eye, to zoom in, on their own organizations, businesses, products and clients (microscope).

Chapter Four A Country Is a Business

This chapter helps managers perceive countries as businesses, and develop the ability to "read" a country's basic GDP data as if it were a business profit-and-loss statement, drawing strategic conclusions about the country's market size, saving and investment, growth orientation, and future prospects, useful for guiding 6 business decisions

Chapter Five Analyzing Engines of Growth

Growth is crucial for businesses and no less crucial for countries. After reading this chapter, you should know how to measure for any country, and any period, the underlying reasons the country did (or did not) enjoy economic growth

Chapter One. Global Crisis 2007-2009: Causes & Opportunities

Learning Objectives

After reading this chapter, you should understand the basics of scenario planning, why it is important and how great organizations used it to meet large unexpected challenges You should understand what contrarian thinking is and how it can protect managers from herd groupthink; You should know the difference between an analyst and a strategist, understand which thinking predominates in your own mind, and know why both types of mindset are crucial for meeting global challenges You should grasp how Americas response to the 2000-1 dot.com bubble directly led to the 2001-7 housing bubble, and why this bubble ultimately collapsed. 8

Learning Objectives (continued) You should know what organizational resilience is, and why it is of growing importance; you should be able to gauge your own resilience and that of your organization. You should understand what a tipping point(critical mass) is, and how it causes markets to shift quickly from bullish to bearish and vice versa. You should understand how and why markets are driven by the interaction of minds (market psychology) and money (cost and availability of credit and liquidity), and how to track the dynamics of changing market sentiment.
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Toolbox
Tool #1: Scenario Planning: How to dispel denial by making worst-case scenarios concrete and believable.

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Definition
Groupthink - a type of thought exhibited by group members who try to minimize conflict and reach consensus without critically testing, analyzing, and evaluating ideas. Individual creativity, uniqueness, and independent thinking are lost in the pursuit of group cohesiveness, as are the advantages of reasonable balance in choice and thought that might normally be obtained by making decisions as a group. Groupthink may cause groups to make hasty, irrational decisions, where individual doubts are set aside, for fear of upsetting the groups balance. 11

Action Learning: Contrarian Thinking.

Ask yourself, at the present time: What are the prevailing common assumptions about local and world markets? What are the implications, if some or all of these assumptions are wrong by 180 degrees (i.e. if the precise opposite is true)?
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Action Learning: One Picture Is Worth a Thousand Words:

Graphs of key variables can alert us to looming crises.

What three graphs do you have in front of desk, in your workspace, that you view daily, that serve to alert you to potential risks and market declines? Do you update them regularly?
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Average House Price

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Tipping Point (critical mass): When More than X% Become Bears

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Tipping Point (critical mass): Pessimism is Self-Fulfilling

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Analyst? Or Strategist?
Ask yourself, are you primarily an analyst? Or a strategist? Definition: Analyst: An employee of a brokerage or fund management firm who studies companies and makes buy and sell recommendations on stocks of these companies. Strategist: Those who weigh broad market sentiment and macroeconomic factors in order to assess the overall business environment , as an aid to those building buy and sell recommendations.

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Understanding 2007-9: Six Key Principles

1. In capital markets, it is not stocks, bonds and other paper assets that are bought and sold. It is RISK!
2. In global capital markets, one form of risk is consistently underestimated. It is called perfect storm risk. 3 . Be sure you understand the dynamics of the industry in which you do business. 4. Capital markets will regularly have major crises, every five years or so.

5. In the contest between Wall St. and regulatory bodies, Wall St. will always win.
6. In a perfect storm, one domino topples another, amplifying the 19 impact by a thousand times.

U.S. Year-to-year % change in corp. net income, 1962 2008.

---- Incl. financial sector ---- Excl. financial sector

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Toolbox
Tool #1: Scenario Planning
A scenario is simply a story, describing vividly what may happen and how it will come about. Because it is vivid, it is believable, even though improbable. Scenario analysis: a) describes perceived current realities as a mental map (which may differ widely among members of the group constructing them); b) defines several alternative images of the future, in tangible, concrete form; and c) describes paths that could be followed that generate these scenarios.

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From Risk to Opportunities

In any industry, when the rules of the game are being radically rewritten, there are huge opportunities for persons with energy, wisdom and creativity. The financial services industry is a vital and integral part of the global economy. Global business and trade is dependent on a smoothly-operating global capital market. Hence, the financial services industry will be reinvented and reborn. Those who lead this process leaders with courage and vision will do both good for society and do well for themselves. We urge all those who seek careers in financial services not to abandom them, while cautioning that the road ahead may well be rocky for several years.
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Chapter Two What Is Your Story? How to Build Powerful Global Narratives
Learning Objectives: After reading this chapter you should understand why it is vital for managers to acquire their own macroeconomic analytic tools and develop their own perspective on key trends in global markets. You should understand precisely what a global manager is, and how a global manager thinks and acts on that thinking. You should know what 'teleology' (the study of cause and effect) means and why becoming good at understanding teleology in global markets is important
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Learning Objectives (continued): You should also understand how a systems thinker uses dynamic feedback loops to understand fundamental causality as it unfolds in world markets. You should be able to construct feedback loops that identify the key dynamic processes occurring in global markets. You should be able to use the GELT model (geopolitics, economics, lifestyle, technology) to identify key global trends and build a narrative from them that leads to global strategies. You should be familiar with the recent history of global markets and have in your mind a teleological account of events as they unfolded from Nov. 9, 1989 to the present.
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The featured tool in this chapter is: Tool #1 GELT Geopolitics, Economics, Lifestyle, Technology.

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Teleology: Global Cause and Effect

Definition: Tel-e-ol-o-gy. n. Gr. telos, an end; -logia, study of; the quality of being directed toward a definite end, or of having an ultimate purpose. -Webster's New World Dictionary

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The Teleology That Created A Market Leader

Jorma Olilla, while vacationing in southern France in Nov. 1989, observed the Fall of the Berlin Wall. He reasoned: the fall of the Wall will quickly cause the two Germanys to unite, this, in turn, will hasten European unification, and the single European Market in turn, the European Single Market will need, above, all, communication, communication will require mobile phones, because of difficulties in integrating national land-line systems. 27

Unification of East and West Germany

Creation of European Single Market Mobile speeds Single Market

Establish Nokia Mobile

Fall of the Berlin Wall 9.11.1989

Need for Europewide communication

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GELT Geopolitics, Economics, Lifestyle, Technology.

- Geopolitics: Instabilities and changes resulting from political trends, in various regions and countries in the world.

E - Economics: Economic trends, including exchange rates,

economic growth, trade, exports, finance, interest rates, capital flows.

L - Lifestyle: Sociology, the way people live, social trends, cohort

effects (differing values across age groups.

T technology: Technology trends, new technologies, new basic

science that can lead to new technologies.
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G - Geopolitics Instabilities and changes resulting from political trends in various regions and countries in the world. Example: The Iranian ayatollahs, the war in Georgia, the new French President, the American 2008 Presidential elections. E - Economics Economic trends, including exchange rates, economic growth, trade, exports, finance, interest rates, capital flows. L - Lifestyle Sociology, the way people live, social trends, cohort effects (differing values across age groups). Ipod, Iphone, are lifestyle products. T - Technology Technology trends, new technologies, new basic science that can lead to new technologies (new ways to produce semiconductors, new ways to test and evaluate them, new technologies for increasing transistor density on microprocessors, etc.).

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Geopolitics

Economy

Lifestyle

Technology

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Step 1: The Shopping List

List the major trends, over the coming 3-5 years, that you believe will impact the world. Put them down quickly. Each individual should take 10 minutes to write a 'shopping list, then the team should together build a single list based on the lists of its members. Write down the key trends irregardless of their GELT category. Write them on a flip chart page.

Step 2: Categorize
Beside each trend, write a letter: G, E, L or T. Depending on its category. Some trends may be hard to categorize: if so, then write down two letters, e.g. G and T.

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Step 3: Prioritize
Of the entire list, select the major trends that the team believes will be most important for ..'s industry. There should be 10-20 of them.

Step 4: Quantify
For each trend, assign two numbers on a scale of 1 to 10. First: IMPACT: the impact of the trend on the industry, from 1 (very low) to 10 (very high). Second: TIMING: WHEN the trend will fully be felt. 1 = right now, immediate. 10 = not for 5 years. There can be a range: e.g. 3-5 from 18 months to 2 1/2 yrs.

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Impact L G
Berlin Wall Falls; Germany reunited Need for Europe-wide Communication

T
Build Cellular Technology

E
European Single Market hastened

Timing (years) 0 1 2 3 4 5
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Tool: Feedback Loops

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Mortages widely exceed house value; Net equity is negative

Mortgage owners default; banks foreclose

Housing prices fall

Banks sell foreclosed properties

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Understanding History: Teleology, Feedback and Dominos

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Teleology: from Mexico to Argentina

1. Mexico: borrowed Dollars.. High interest rates 2. flight of capital.sale of pesos.sell $... 3. Crisis: peso is devalued3.50 to 7.00 4. Emergency loan: IMF $50 b. (lenient) 5. Mexico recovers 6. Washington: strengthen the dollar..raise interest rates 7. Asian countries in BIG BIG trouble 8. Thailand: flight of capitalbaht collapses 9. IMF loan 10. Other Asian currencies fall rapidly: 1997/98 11. oil prices fall rapidly Russia loses revenues 12. BRAZIL
Nanyang Business School MBA 2008 S. Maital 38

Global Risk: Taxonomy or Ecology?

Taxonomy shopping list of kinds of risk

Ecology global analysis of systemic risk

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Chapter Three Risk Management with Telescopes & Microscopes

This chapter explains that managers need a peculiar type of vision -- one that enables them, with one eye, to zoom out on global events and to tracking minds markets and money all over the world (telescope) and with another eye, to zoom in, on their own organizations, businesses, products and clients (microscope).

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Microscope: On a scale of 1 to 10: How 'sharp' is your zoom-in microscope (i.e. how well do you understand the products, strategies, operations, and business design of your organization?) (1 is 'poor'; 10 is 'excellent' or superior). 1________________________ 10 Business Design

1________________________ 10 Products
1________________________ 10 Operations 1________________________ 10 Strategies Average score / 10:

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Telescope:
On a scale of 1 to 10: How 'sharp' is your zoom-out telescope (i.e. how well do you track and understand global trends and markets ?) (1 is 'poor'; 10 is 'excellent' or superior). 1 ____________________10 Global economics 1 ____________________10 Global finance 1 ____________________10 Global technology 1 ____________________10 Global social trends Average score / 10: Y = _____

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Place yourself in the 2 x 2 diagram below, by plotting the (X,Y) coordinate.

Telescope

10

1 1 10

Microscope

What action items emerge from this analysis? How can you increase the resolution of your microscope? Of your telescope?

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Case study: Bankers Trust: When value-at-risk risk management models collapsed

Case Study: Goldman Sachs Heads for Harbor

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Who and What Caused the Crash of 2007-9? The Three Streets: Wall St., Main St., Massachusetts Ave Wall Street (capital markets): Exotic securities that were complex, risky, and largely unregulated; Compensation: bonus systems that encouraged bankers and traders to accept undue risks, because rewards were based on returns but not on risk Leverage: Investment banks got the American Securities Exchange Commission to relax their capital requirements and vastly increase leverage (ratio of debt to capital); Main Street (ordinary people) Americans lived well beyond their means, overspent and overborrowed; small and midsized banks overlent to builders; greedy homeowners used inflated home prices to borrow and spend;

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Massachusetts Ave. (Federal government) Gramm-Leach Act let commercial, investment banks recombine; Alan Greenspan (Fed Chair) lowered interest rates drastically and excessively, fueling the housing bubble; Community Reinvestment Act: forced lending to people with bad or no credit rating.

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Borrow money, buy assets

Bubble
Asset prices rise

Profits fuel more leverage

Sell assets to reduce debt

Asset prices fall

Collapse

Losses fuel more deleveraging

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