As the FT reported in January 2012, “…in the United States and other developed markets, SMEs commonly account for half or more of gross domestic product…. A recent study from the European Commission indicates that SMEs generated 85 per cent of all new jobs in the European Union from 2002 to 2010…“  In an April 2012 interview with this site, Prof. Mark Hart (who heads up the Global Entrepreneurship Monitor – GEM) further underlined this stating, “…It’s clear to me that small businesses, particularly micro-enterprises, have been responsible for the majority of the gross job creation in the last five years… particularly through the recession….“

Even more astonishing is the fact that most of these businesses are (as the description suggests) small.  The overwhelming majority are owner managed with only a handful of employees.  Some will grow and scale to become huge enterprises, but in the main these are businesses which scale to a size where they’re sustainable and continue to provide a good income for their owners and employees.  Another critical characteristic is that many of these enterprises cost very little to start meaning that for under $1,000  – people can become entrepreneurs.

To learn more about the phenomenon of micro-enterprise, I spoke to Chris Guillebeau, author of the $100 Startup.

Chris is a writer, entrepreneur, and traveller. During a lifetime of self-employment and ventures ranging from online publishing to volunteer work in West Africa, he has visited nearly every country on earth before the age of 35. Host of the World Domination Summit, an international gathering of creative people, Chris is focused on encouraging individuals to live fulfilling lives with inspiring and practical advice.

Q: Why do people become entrepreneurs?

[Chris Guillebeau] For a variety of reasons! I think some people are drawn to the independence of owning a business.  I was… I wasn’t a very good employee and wanted to make my own way.  In the early days, my motivations weren’t necessarily about building a company or changing the world- I just needed to find a way to pay the bills….

Many people also enter entrepreneurship because of a transition or shock.  A lot of people we talked to in the $100 Startup had been laid off or weren’t able to find a job in our difficult economy.    A lot of people also never intend to become entrepreneurs but stumble into it.  They may have some kind of hobby, skill or passion… and discover that other people are willing to pay for it.

Q: Are there any common threads to creating a successful business?

[Chris Guillebeau] I think it’s about usefulness! People talk of ‘following your passion‘ but there are plenty of things people are passionate about that nobody will pay them money for, so you can’t just tell someone to just follow their passion.  Many entrepreneurs have though, built businesses around things they are passionate about.  The missing piece? usefulness…

We say the magic formula is: Passion + Usefulness = Success.  You may have to go through a number of ideas to find the one that meets this formula, but when you do, that’s when success comes.

Q: What are your views on the fact that many people don’t start a business as they feel handicapped by finance?

[Chris Guillebeau] I think that’s the wrong perspective.  It depends, of course, on what kind of business you want to start.  If you need a manufacturing facility or if you want to build a new automobile… then you’re going to need financing… but most of the businesses we looked at are micro-businesses and didn’t need financing.  They didn’t… in general… need more than $1,000 to start and in many cases required less than $100.

Entrepreneurs have to focus on how a business makes money and focus on that rather than the expense side of the business.  That also allows you to start quicker and instead of deferring your idea, you could get to market in 30 days.

Q: Has the last decade changed people’s views on becoming entrepreneurs?

[Chris Guillebeau] People have always been entrepreneurs, what’s changed is connectivity.

We can now relate to people all over the world and get to market really quickly.  The increase in confidence over online shopping has made a huge impact too.  This trend started in North America but is now present worldwide.   When I was first working online, some 14 years ago, I had to spend over $150 on a domain name… figure out where to host it… and then realise that people were uncomfortable with their credit cards and so on.  Now a domain name is a few dollars and you can host your site for free. You could generate traffic in 24 hours, and sell within a week.  It’s incredible.

Q: Are there any attitude hurdles that stop people starting businesses?

[Chris Guillebeau] There’s certainly a perception that to start a business, you have to write a 60 page business plan… put together a finance proposal… and be prepared to ask 10 banks for money and be turned down and so on.  We hear a lot of stories just like this through the news and media.

In reality, I think people don’t know what ‘the next step‘ is.  There’s a lot of people who want to strike out on their own, but don’t know how to do it.

Q: Is there a role for mentoring in starting a business?

[Chris Guillebeau] I think there’s a role for learning.  You can learn through mentoring, independent study or- most importantly- through the doing.  You learn a lot through trial and error- hopefully more trial than error I might add!

Q: Are there any common mistakes that start up businesses make?

[Chris Guillebeau] The most common is deferring action and getting stuck in paralysis… The second most common is finance… Investing too much in unproven concepts for example.   People can, and should, start their businesses as micro-enterprises to test their concepts and reduce risks.

Q: Are there any common growth strategies employed by businesses you’ve spoken to?

[Chris Guillebeau] I think it’s much easier to grow a micro-business than start it.  Once people got to a certain number… which varied depending on industry…. but say $1-2,000 per month – there’s lots of things you can do to grow that business.  You can reach more customers, sell more to existing customers through up-selling and through reselling products.   For product based businesses many must also consider whether there is a service they can offer to complement it.  A lot of people have product based businesses and don’t realise that their customers want personal help using the product.  The same works the other way round… Many customers of service based businesses just want it ‘boxed‘ and simplified.

Q: What are your views on the attitudes to entrepreneurial failure in society?

[Chris Guillebeau] One of the things I’m interested in encouraging people to think about is the whole area of risk.  What really is risky?! In many ways I think it’s actually much safer to take things into your own hands rather than trusting your destiny to an uncertain jobs market.

If we consider failure… I am interested in reducing the possibility and effect of failure.  If you don’t spend a lot of money on something and it doesn’t work out… is it really a ‘failure’?  Most entrepreneurs start a lot of different ventures.  Some work better than others, but that’s totally normal and expected.  If one thing doesn’t work out- it doesn’t mean that you are  failure.  Your reputation is created on all the things you do.

———

Over the last decade ‘entrepreneurship‘ as a concept has evolved from being something simple into a complex and jargon-rich world generating such an overflow of information that many people feel too overwhelmed to participate.

The fact is… entrepreneurship is simple… it is something that people have been doing since practically the dawn of civilisation… it has simple rules, simple outcomes and very few barriers to entry.  Technological change has also created an environment which, more than any other time in history, makes it viable for practically everyone to be an entrepreneur of some sort.

So why aren’t more people turning to entrepreneurship?  As Chris identified in our conversation, it’s not for the lack of will – a lot of people want to start their own business!  It’s knowing what the ‘next step‘ would be in the journey.

Fortunately… as with most things in business… the answer to this question is simple.

Just do it.

An Interview with Interbrand Chairman, Rita Clifton

In February 2012 in a paper titled, “The Role of Brands in Human Culture” I noted the significance of branding in our world.  To illustrate this, we should note that the top 10 global brands (as measured by the Interbrand index) have a combined value of over $432 billion (against their total market capitalisation of $1.7 trillion).  That means that 24% of the real economic value of these organisations lies in their brands. Think about that for a moment… That’s $432 billion of real economic value which exists in potentially the most intangible asset of a business, an asset which only exists in people’s minds.

Brands are more than just intellectual property, they become the underlying common ethic that affects all aspects of a firm’s activities.  In the above paper Philip Kotler (widely regarded as the most influential marketer of all time) notes that, “…An increasingly number of companies see their brand as the platform for running their business.  The brand creates an identity for the product and/or company in the marketplace.  It requires the company to think deeply about its mission, vision, and values. The company has to work hard at developing the image that it wants customers to have of the offering.  The brand must not only convince prospective customers and draw them to the brand but also be deeply believed in by the employees and other stakeholders of the company...” That note about belief is critical.  Branding is a psychological entity that manifests economic value and firms of all sizes.

To learn more about the economics of branding, I spoke to Rita Clifton, Chairman of Interbrand London, who are regarded as one of the world’s top branding consultancies and the pioneers of brand valuation. 

Rita Clifton features regularly on a wide variety of TV and radio programmes on business, brand, marketing and communication issues, including CNN, the Money Programme, BBC Breakfast, Channel 4 News, BBC World Service, the Today programme, The Bottom Line with Evan Davies, Sky News with Jeff Randall, and Radio Five Live.  In 2006, she was appointed Visiting Professor at Henley Management College and in 2009 was made President of the Market Research Society.  She has also been on the Advisory Board of the Judge Business School at Cambridge University, and on the Business Advisory Board for the Duke of Edinburgh’s Award.  She is a Fellow of the Royal Society for Arts and of the Marketing Society, a member of the Marketing Group of Great Britain, the Account Planning Group and the Institute of Practitioners in Advertising. She has chaired several industry committees, including the Code of Advertising Practice to Children.   Rita Clifton has been voted one of the 75 Women of Achievement in the fields of advertising, media and marketing over the past 75 years, has been named in the ‘Power 100′ list by Marketing magazine and shortlisted for the Credit Suisse Outstanding Business Woman of the Year.

Q: To what extent do you feel brands are responsible for creating value in companies?

[Rita Clifton] The starting point is to realise that brand, in whatever type of organisation, is the most important and sustainable asset you’ve got.  People may leave or die, buildings may dilapidate or fall down, products and services may become obsolete… The thing that lives on is brand.  That is the element which generates long term sustainable value and wealth, and that means you have to manage it… and look after it properly!

Looking at how brands create value…  Brands create demand and, most importantly, they create secure demand.  Some people say their most important asset is people.  I would say, “yes but organised to do what?“.  If you’re not trying to build a consistent idea, you are just another group of people doing stuff in a sea of other people doing similar stuff.  You must assemble and rally people’s efforts in a very particular way that’s going to give you long term competitive advantage.  That must live on even if people leave to do other things or- in the most extreme circumstance- pass away.    This even applies to tiny companies.  If you’re trying to build something that you want to pass on to your children or other members of your family, you need to build a brand.  It can’t just be about you and what you’re doing at the moment.

If you have a strong brand, that means you have a loyal customer.  If you have a loyal customer, that gives you more security of income, earnings and employment.  Sometimes people underestimate this important social benefit to brands, let-alone the economic benefits.

Q: Do brands create economic values at the country and regional level?

[Rita Clifton] If you look at just how many brands the US have got in the top 100 most valuable brands in the world, you will find it’s about 50.  This is down from around 65 when Interbrand first started producing the league table, but it’s still an impressive number.  American brands have been really important engines for the nation’s success.  They have generated secure earnings domestically and in an export context for the US.  In terms of exporting ‘American Dream’ brands such as Coca Cola, they have been astonishingly successful.   The profits from these activities come back to the US based businesses and are diffused into the economy.

China is extremely keen on building brands, even their Vice Premier has made this point clear.  You have to remember that China is still theoretically a communist country but even so talks about how important brand and branded commodities are to China’s social and economic progress.  China realises that he who owns the brand, owns the wealth…   For nations, brands give economic control, security and choice and are therefore extremely important.

Q: Have events such as the Arab Spring affected those region’s brands?

[Rita Clifton] The issue about the Arab Spring relates to the fact that for businesses to survive, let alone brands, you need a secure and stable base.  You need secure economic and social conditions  to reduce risk.  You need a secure and stable workforce, you need commitment from that workforce, you need absolute  consistency and unless you have these stable socio-economic conditions you cannot create the environment in which a brand can grow.

There are a lot of positive opportunities emerging from the Arab Spring too as people perceive this as being a region which will gain economic freedom and allow people to create businesses, brands and value in the global marketplace.    Countries need economic security and prosperity- that is what creates a more stable and satisfied population.

Q: How do you value a brand?

[Rita Clifton] We pioneered brand valuation at Interbrand in the 1980s.  What became very clear in the mergers and acquisitions climate during that period was that companies were paying an awful lot more for companies they acquired than the tangible book values.  Technical accounting practices didn’t really allow for that.  The real value of an organisation comes from the value people are prepared to pay for the company itself, or its products and services.

Interbrand applies similar principles to robust financial analysts to create the concept of brand valuation. We look at the projected future earnings of a company, and look at the role of brand in generating those earnings, and how secure those earnings are.  In some industries the role of brand is very high.  For example, in the luxury space more than 70-80% of the value of firms can be attributed to brand.  In industries such as petrol retailing the figure is much lower as the product is a commodity and demand is driven by other factors such as convenience and price.    We must therefore ensure we weight the earnings calculations to take into account the role that brand plays in generating those earnings.

Brand strength is the next component.  That is the factor which creates the discount rate.  If you have a strong brand, it reduces the risk of your proposition while a weak brand does the opposite.  If I was Coca Cola, promising to pay you £1 in 10 years time you would assume I have the power to pay you back…. If I was ‘Smiths’ Cola, or some other unknown company, you may worry if I was going to be there or not.  Brand strength calculations are based on ten factors, and give a risk grade which, when applied to the other elements, gives you a net present value for the brand.

It’s important to note that brand strength is one of the only dimensions over which a firm has a great amount of control.  You can resolve how clear your brand is, how consistently it’s applied across the customer experience, the commitment levels within your organisation, the relevance and a whole host of other factors.  You can address each of these to build a strong and secure brand.

Q: Has the growth of the internet impacted the economics of branding ?

[Rita Clifton] It’s certainly changed the economics of marketing and communications….

What’s very interesting about the digital world is that it has enabled people to know much more about organisations.  In the more ‘straightforward‘ broadcast and traditional media worlds, if you invested a lot of money in marketing and communications- these investments would typically be one-way telling consumers about your brand.  If you were lucky and they paid attention, they may try your product and buy again if they liked it.  The purchase process is now a lot more fluid.  Regardless of where you hear about a brand, you may look into it.  You may view peer group opinions about that brand and be affected by those views.  Don’t forget that people tend to believe peer group opinions more than the company’s own marketing and communications.  People regularly tap into conversations about brands and those conversations influence whether or not they purchase.  This feedback mechanism can also feedback to the organisation as consumers can let companies know directly whether they did or did not like a given product or brand. Or indeed, whether or not they like the company’s behaviour in the round.

The upshot of all this is that if you have a great brand that does what it says it’s going to do and really does deliver authentically, you can spread quickly without spending huge amounts of money on public advertising.

Google is a great example.  In the old world of brands, you may have been successful in one country and then you would set-up maybe a factory in another country and start marketing there to get distribution and so on.  You would have to grow country by country, which would take a while.  Google went from a boy’s bedroom idea to a top 10 global brand within 10 years.  This growth obviously required enormous effort and investment, but so much of its original success was word of mouth about a breakthrough product .  Google had to create a great product, and a great brand around it.  It wasn’t just a bigger search engine… it was clear, simple and charming against a backdrop- at the time- of a very messy internet.    Facebook are on the same journey- creating a great product and then tapping into a global community.

There are risks attached to this, especially if you are in a competitive sector.  The digital world has created lots of opportunities, but has also created astonishing speed and scale.  You can destroy a brand’s reputation at a speed that can take your breath away.  20 years ago, if you had an environmental problem in some obscure country around the world- you had a while to repair the damage and hope that not too many people found out.  In this era of digital-activism, the ghosts of corporate skulduggery never get laid to rest.  If you do something bad…. exploit a workforce… have an environmental disaster…. the news of these events can spread rapidly.  It takes a long time to build a reputation and trust, and it only takes an instant to lose it.

Q: Has the digital world changed the nature of intellectual property?

[Rita Clifton] IP is always a challenge when you’re dealing with global markets.  Some countries have different standards applied to intellectual property than others, and in some parts of the world there are problems with counterfeiting and copying.  What you find in these cases is that countries who engage in these activities… when they start to invent things for themselves they suddenly they get interested in protecting IP!    This has also been a commercial challenge through all eras of business, you only have to look at the punch-ups between Google and the publishing industry, YouTube and the film industry and similar cases to see this in action.

The difference now is that these challenges are more widespread.

Q: What is the impact of corporate social responsibility and philanthropy on a brand?

[Rita Clifton] Particularly when measuring brand strength, we find that corporate social responsibility has an effect.  In terms of risk, if you’re not responsible, and are not behaving in a way to promote trust, it puts your brand strength score at risk.  This particularly affects dimensions like commitment.  If you are not behaving well as an organisation, then the commitment of your people may wane- introducing risks into your brand.  If you think also about consistency… If your brand promises to behave in a certain way and doesn’t,  then your consistency score will reduce.

If you are a good corporate citizen, your people are more likely to be committed and you are more likely to be relevant to your consumers.  If you have a reputation to protect, you are likely to do the right thing.  Your reputation is a critical indicator of whether you can generate long term sustainable value.  If you damage your reputation your short and long term prospects will be adversely affected.

Our research suggests that 2% of consumer choice can be explained just by corporate citizenship factors, it’s even higher in the business to business sector.  This may seem like a small number, but in today’s highly competitive marketplaces,  it’s certainly worth having.

Q: What makes a great brand?

[Rita Clifton] The first and foremost in my view is that you must be clear.  If you’re not clear about what your brand stands for, how that’s different and better from the competition now and in the future,  you’ve got an issue.  This clarity of proposition has to be shared throughout your organisation so that your people know how to make the company successful and make their jobs more secure.

Secondly, you must be consistent in everything you do.  That doesn’t just mean having the same logo on everything.  It also means behavioural consistency.  How are you building the clear idea and entire customer experience together as a team? There’s no use pretending you are a smiley customer service oriented organisation when the reality is that you’re an axe-murdering culture on the inside.  You need to make sure all parts of your operations work coherently with your brand.

The third area is leadership.  This obviously is linked to who runs the company or who is seen to be in that role.  If you look at Steve Jobs, he was an amazing leader.  He epitomised the brand… clear, stylish and absolutely about humanising technology… making sure technology worked for people!  Leadership is also about restlessness, innovation and setting your agenda in your markets.  This is very closely correlated with long-term value.

————————————————–

There is no doubt that brands are important and always have been.  Branding, itself, is not a new phenomenon, but our understanding of what branding means is changing.

The astonishing growth in communications, media and information technology has meant that our understanding of brands has moved very quickly from being “brands are just a logo” to “brands are everything“.    We now understand that brands are wealth creating, wealth defending and immortal.  They are emotional and cultural – and represent the point at which the deepest recesses of our psyche connect with the entity being branded (whether that is an individual, a company or even a country).    For us as consumers, brands are no less important.  They help us make sense of our environment, and build real tangible bonds with the world around us.

The smartest firms are the ones who understand these profound facts and build branding into the very heart of their proposition from the very first day they open for business.

As David Ogilvy (widely regarded as the father of advertising) once said, “…any damn fool can put on a deal, but it takes genius, faith and perseverance to create a brand…“

Guest article written for AllAboutAlpha.com – the official publication of the  Chartered Alternative Investment Analyst (CAIA) Association

Originally posted at: http://allaboutalpha.com/blog/2012/04/30/a-life-changing-600-million/

Impact Investments are a maturing asset class.  These are investments that go beyond financial return to deliver a measurable positive social or environmental impacts for the beneficiaries they affect.  JP Morgan estimate that over the next decade, this asset class will constitute an investment opportunity of between US$400 billion and US$1 trillion, generating profits of between US$183 billion and US$ 667 billion.

For governments, impact investment provides a unique bridge between the public and private sector, allowing innovation and entrepreneurship to be applied to social issues which would typically have been the prevail of government institutions to resolve.  The United Kingdom is one of the global leaders in this field with over 30% of all business start-ups in the country being socially motivated.  Following a decade of planning, Big Society Capital was launched this year as, “..an independent financial institution established to develop and shape a sustainable social investment market in the UK…“

To learn more about Big Society Capital, we spoke with Chief Executive Nick O’Donohoe.  Prior to taking this role, he was Global Head of Research at JP Morgan (responsible for the firm’s Equity, Credit, Interest Rate, FX, Commodities and Economics research departments).  He was also a member of the bank’s management committee, and sat on the Executive Committee of JP Morgan Chase (including their Social Finance Unit).   He co-authored “Impact Investments: An Emerging Asset Class”, published by JP Morgan and the Rockefeller Foundation in November 2010. Prior to JP Morgan he worked at Goldman Sachs. He is a board member of the Global Impact Investing Network (GIIN). 

Q: What does social investment mean to you?

[Nick O'Donohoe] Social investment we define as investment made with the intent of creating a positive social impact as well as generating some financial return.  I would distinguish that from ‘socially responsible investing‘ in the sense that socially responsible investing starts with a good financial proposition and then tries to build around that with a more sustainable framework.  Impact investing starts from the other end.  It starts with an issue… this could be a problem, a social issue or so on.  In emerging markets this could be things like education, healthcare and water or in the developing markets it could mean things like support for prisoners, getting young people back into work, and more.  Impact investors start with an issue and then try to build a viable, sustainable financial model around that.

Q: What was the rationale behind Big Society Capital?

[Nick O'Donohoe] Big Society Capital has a simple rationale.  The government believe there is significant appetite for this type of [impact] investment. From individuals to foundations, investors want to place at least some of their net worth in these kinds of investments.  On the other hand we know there are 65,000 social enterprises in the country along with 150,000 charities and a whole network of for-profit companies that are socially oriented.  They all find it very difficult to attract capital.  The reason these organisations are disconnected from capital and potential investors has largely been due to a lack of intermediaries such as social investment funds, social banks and other vehicles.  Big Society Capital’s mandate is to build that bridge and support the development of an intermediary layer.

Q: How is Big Society Capital funded?

[Nick O'Donohoe] There are two different sources.

We have access to dormant accounts from all banks and building societies.  These are accounts that have been dormant for longer than 15 years.  That provides (we believe) around £400 million which is then supplemented by £200 million by the ‘Merlin‘ banks – the UK’s 4 large clearing banks.

Q: What is the role of social entrepreneurship in addressing problems in society?

[Nick O'Donohoe] I view the social sector as a pseudo middle ground between the public and private provision of services.  We tend to get involved in a binary discussion around whether the public sector should provide a service meaning the service may be delivered inefficiently, without innovation and potentially without for money…. or whether private companies should socially oriented services where usually profit comes before people.

The social sector offers this middle-ground where you’ve got organisations that have a social purpose.  They care about the level of service in a real way, but also have the financial disciplines of a for-profit company as they must be sustainable.

In the same way that business entrepreneurship has transformed industry since the early 1970′s,  social entrepreneurship can transform the social sector by having people who are willing to take risks and innovate to help address social issues.

Q: What are the methods by which you invest?

[Nick O'Donohoe] Our restriction is that we must invest in intermediaries rather than front-line organisations.  We’re looking to try and help start social investment funds and have put money into a franchising license fund, for example, that buys franchise licenses and makes them available to unemployed people around Manchester.  We’ve also put money into a community energy fund that targets the bottom 50% of postcodes in the UK and provides funding for organisations to start generating their own power, feed it into the grid, and generate revenue for other projects!

I think we’ll see a continued evolution of these and other funds in areas like community access.   There have been significant amounts of legislation which recently made areas of community access available for purchase.  The purchases do, however, require funding.

The other area is broader social impact bonds.  These support social organisations in the delivery of payment by results.  Examples of this include the Peterborough Social Impact Bond.  One of our investments in this sector has been a project organised by the Private Equity Foundation and delivered by a charity called Tomorrow’s People that provide mentoring to at-risk kids in London.  We have also invested in a similar project to this in the North West called Merseyside Connections.   Here we provide funding for necessary interventions.  If these interventions are successful, the government saves money and the government pays back the investors.

Q: How do you measure impact and return on your investments?

[Nick O'Donohoe] We have a financial discipline driven by a requirement to protect our capital and hopefully earn some very small return on it.  We apply the normal financial discipline that any financial investor would do.  We supplement that with a set of social criteria.

You have, to some extent, look at these investments on a case by case basis.  What we’re trying to do however is develop 10 broad sector themes to invest in.  This could be things like education, health, recidivism and so on.  Within each of these areas, we want to create key indicators we can use to measure success. It’s still a work in process, but our ambition is to help the sector coalesce and broadly agree around a group of key indicators and measures.

Q: Do you find there are any particularly unique risks associated with this sector?

[Nick O'Donohoe] From a risk perspective… most of what we do is very early stage in markets that are very embryonic.  Early stage investing is very difficult and financially risky meaning that a lot of what we invest in won’t work.  A lot of what we do is, in effect, pilots to see if individual projects or funds can generate some positive return.  If they do, we can then scale them up.  You have those risks in any investment!

What’s incremental in the social investing world is the risk associated with a lack of social performance.  You may give money to someone who gives you an investment return, but they have made no social impact.  People care about not how much money we invest in a particular place, but what impact we are having… what changes we are making… who are our beneficiaries and how are they being helped.  The risk is projects that may benefit the wrong people, or nobody at all.

What does this mean for Investors?

The UK Government has put a lot of faith in social investment.  A key report published by The Rt. Hon Francis Maude MP (Minister for the Cabinet Office) noted that the UK Government wants, “…a bigger, stronger society. One where communities and citizens have more power to shape their lives and determine their destinies.” They continue to state that “This [impact investing] is not about handouts – it is about encouraging a new, self-sustaining market to grow, free of state interference. We want more social investment opportunities to be available to citizens and the managers of our savings. In the same way that finance flowing to business start‑ups is the lifeblood of our economy, so it will be with social enterprises. Change in this market will not take place overnight, but it will be transformative in allowing social ventures to scale up and take on new challenges.”

Many in the institutional investment community worry that such schemes handicap investors by limiting what they can invest in and, indeed, many have criticised the impact investing world for being one surrounded by hype.    These worries and accusations are borne from the fact that many find it difficult to disconnect any enterprise that works for the social good with the word ‘charity‘.

Impact investment provides an essential instrument in the arsenal we use to realistically tackle practically every major social issue afflicting the developed and developing worlds.   This is an industry which from day one has geared itself around creating a ‘business case‘ for social change and a commitment to measuring return.

As Benjamin Franklin himself noted, “…an ounce of prevention is worth a pound of cure“

In this exclusive interview, we speak to Ingrid Newkirk (Co-Founder and President of PETA – People for the Ethical Treatment of Animals). We discuss the relationship of our species with the animal kingdom. We look at issues ranging from animal rights, to the use of animals for food, clothing, entertainment experimentation and more.

http://thoughteconomics.blogspot.co.uk/2012/05/humanitys-relationship-with-animals.html

Guest article written for AllAboutAlpha.com – the official publication of the  Chartered Alternative Investment Analyst (CAIA) Association

Originally posted at: http://allaboutalpha.com/blog/2012/04/26/the-brand-of-hedge-funds/

With almost US$2 Trillion under management, the hedge fund industry is a significant component of the global financial market.  To put their size in context however, it is important to realise that the size of the world equity markets are around US$30 trillion, a factor of more than 10 times larger.

During and immediately after the 2008 financial crisis, hedge funds became a convenient media and political scapegoat- not just the crisis itself, but for any volatility in practically any market- blamed for spikes in food prices, oil prices and more.   From being the darlings of the financial world, the brand of the hedge fund market faced a significant (and largely unjustified) threat.

To learn more about the realities facing hedge fund brands, we spoke to Ron Resnick, Co-Founder and Partner of CounselWorks, a business strategy and regulatory consulting firm which provides project based consulting and manages compliance and regulatory programs for hedge funds, private equity firms, investment advisers and broker-dealers.

Prior to founding CounselWorks, he was a Managing Partner, the Chief Administrative Officer and the General Counsel of Highbridge Capital Management, one of the largest hedge funds in the world.  Upon joining Highbridge in 1993, and throughout most of his tenure, Mr. Resnick was responsible for the oversight and day-to-day management of Highbridge and its administration, operations, human resources, media relations and legal and regulatory activities.  As a key member of Highbridge’s management, Mr. Resnick, organized and launched over twenty private funds, and played a key role in negotiating the $1.4 billion sale of Highbridge to JPMorgan Asset Management Holdings, Inc. in December 2004, without a loss of operating control by Highbridge’s principals.

Mr. Resnick also co-founded Harmonic Fund Services, a full service, offshore hedge fund administration and consulting company with more than $25 billion in assets under administration, 30 employees and 60 clients.  Mr. Resnick is also a passive partner of Corbin Capital, a $2+ billion fund-of-hedge funds management firm.  Prior to joining Highbridge, Mr. Resnick was an Associate in the Commodities, Futures and Options Group at Skadden, Arps, Slate, Meagher & Flom. He received a B.A. in Political Science summa cum laude from the University of Rochester, and a law degree from The University of Chicago Law School.

Q: How has the hedge fund industry ‘brand’ suffered during the financial crisis?

[Ron Resnick]  The hedge fund industry in general as a brand has suffered during the financial crisis because the poor performance of many funds, and the failure of many funds to function as a ‘hedge‘ and to preserve capital, has caused many people to question the non-beta value of hedge fund strategies and to question the hedge fund fee structure — which is lucrative for fund-owners and not obviously beneficial to investors when funds have poor performance.

I personally think that it’s only the ignorant and populism pandering politicians who treat the hedge fund industry as a scapegoat for the financial crisis.  It was the extremely heavily regulated investment banks who, risking their shareholders’ money, levered their firms up to 40:1!  Most hedge fund managers have a significant portion of their net worth in their own funds.  The interests between hedge fund managers and their clients are largely aligned and, as a result, leverage in hedge funds was a fraction of what it was at the supposedly heavily regulated investment banks.  The problem is that publicly traded companies have an asymmetric risk profile problem in that portfolio managers and executives at public companies are incentivised to take excessive trading risks because if they win big they make a fortune and if they lose big public shareholders and maybe taxpayers pay the price – and those executives then quit their public company jobs and happily get jobs at  hedge funds!  Hedge funds don’t have that asymmetric risk profile problem because, in general, the interests of the hedge fund managers are aligned with their investors.    I think only people who are pandering to perceived public passions are blaming hedge funds for the financial crisis.

Q: How do you feel individual funds themselves, and their brands, have been affected by the crisis?

[Ron Resnick] I don’t think people have lost confidence in the premise of a hedge fund brand; it’s the larger firms that had the brands and the small and mid-sized firms that did not.  With many small and mid-sized firms being hit hard by redemptions and poor performance (and some closing),  investors have gravitated to the larger, best known and most respected hedge fund firms such as Highbridge and Och-Ziff as people perceive safety in blue-chip, long standing firms.

Q: How have events such as the Madoff scandal and the LTCM collapse affected the industry?

[Ron Resnick]  Madoff was only tangentially related to the hedge fund business.  Had it not been for some very lazy funds of funds and Ezra Merkin, Madoff may not even have been grouped with the hedge fund business.  I think he’s more properly grouped with  traditional asset management.  In almost  14 years at Highbridge I literally never once heard the name Madoff.

I think Long Term Capital and  Amaranth aremuch better examples  Those were two well-respected hedge funds.  Long Term Capital which failed to manage their risk despite having Nobel Prize winning executives, and Amaranth which was the first well-respected multi-strategy firm to transform itself into a single strategy firm without telling anybody!  These two episodes really triggered the institutional investor focus on the infrastructure – business management, operations, risk management, legal, compliance – side of the business.

Q: What are they key strategies for funds who want to re-invent themselves?

[Ron Resnick] Before the financial crisis, there was an ever-increasing emphasis on the business side, or the non-investment side, of the business.  This meant expanding and deepening the business oversight, operations, legal, management and compliance aspects of hedge funds.  After Amaranth, I think to a significant extent, the business side became more important and of greater focus for institutional investors than the investment side.    This trend, while still in place, has decelerated.  During the crisis and immediately thereafter the focus was less on infrastructure and more on, “…I need to find a manager, any manager, who can make some damn money!“

Q: What are your views on the criticism of the hedge fund industry having a lack of transparency?

[Ron Resnick] I think transparency in this sense is a red-herring.  A multi-strategy hedge fund could give an investor or the SEC it’s daily trade blotter and accomplish “transparency,” and the recipient would have no idea what to make of the trades, which positions were related to which, which hedges were specific to certain positions, which hedges were fund level hedges, etc.

The focus properly is less on transparency in the sense of positional transparency and more on building-out the business side of the business and expanding the infrastructure and deepening the bench of operational, legal, risk management and compliance talent .  This will give institutional investors greater comfort that professionals other than the investment people are watching the store!

Q: Are there any differences between the challenges funds are facing now versus pre-crisis?

[Ron Resnick] With respect to new funds, they are facing higher barriers to entry than they had before in terms of the minimum assets under management with which one must start trading, and significant costs to build up the non-investment infrastructure side of the business which one must have in place to be plausibly attractive to serious investors.

With respect to rebuilt funds, I think their managers should take up farming.  In this environment here has to be an easier way to make money than for someone who recently lost investor money to return to the same trough and solicit the same people for new money

Q: What is the role of media relations in the often secretive hedge fund world?

[Ron Resnick] Some firms such as Renaissance Technologies relish the cloak of secrecy they cultivate but the fact is that it is not funds that have been strategically secretive as much as it has been securities regulations that prevent managers from talking about their funds or discussing investment performance.  Generally it has been easier and safer to stay away from the media.

Q: Does corporate social responsibility play a role within the hedge fund strategy?

[Ron Resnick] I don’t think there is a specific role.  The purpose of a hedge fund is to make as much money, on a risk adjusted basis, for its investors as possible.  In so doing, the owners of the hedge fund firms get fabulously rich and have very often donated significant amounts of money to charitable organisations. 

Q: How do you feel the new SEC rulings on fund advertising will impact the industry?

[Ron Resnick] I think big brand fund management companies which can afford television ads will look closely at advertising on TV.  Each big firm may be reluctant to be the first one to put an ad on TV on the grounds that, from the point of view of the culture of the hedge fund industry it seems, well, a little cheesy.

But I think some big firm will take the step and others will over time as well.  I think it will be a way for blue-chip firms who can display great long-term track records to raise significant additional assets.

Public advertising also will encourage hedge funds to accelerate the convergence of mutual funds engaging in hedge fund strategies with hedge funds developing simpler versions of their hedge fund strategies which can be packaged in a mutual fund format.  When hedge fund firms see the wall of cash that is available from public channels I think they will develop funds employing simpler strategies and using lower leverage to appeal to a wider section of the “mass affluent.”

Another impact:  If I were a traditional third-party hedge fund marketer I would start looking for another career.

Keep in mind that being able to advertise on TV is completely separate from the question of whether the people seeing those ads are eligible to invest in the funds being advertising.  Nothing in the JOBS Act changes investor qualifications or net worth requirements.

Q: Do you feel these rulings will allow non-US funds to more aggressively advertise in the US?

[Ron Resnick] While I do not think there is a definitive answer until the SEC publishes its proposed rule based on the legislation I don’t see why investment funds which are open to U.S. persons and which are managed by non-U.S. firms wouldn’t be able to advertise.  It would not make sense for non-U.S. firms to advertise in the U.S. foreign funds because taxable U.S. persons generally have no interest in investing in foreign funds.  I think television or radio would be a very inefficient way for non-U.S. firms selling non-U.S. funds to reach tax-exempt U.S. investors (like pension plans) who can invest in foreign funds.

What does this mean for investors and risk managers?

The hedge fund industry is not an island.  As the global financial market evolves, so too must every element within it.  Participants ranging from traditional retail banks through to individual financial advisors all face changing regulations, requirements and changed attitudes from their end customers and investors.

The next few years will certainly see a wide degree of changes within the hedge fund market but we must realise that this industry- more than many parts of the financial world- have the capacity to innovate and adapt fast.  Many funds now have incredibly robust risk management strategies (a magnitude more so than many traditional investment banks) designed to defend capital and secure returns.

Hedge funds attract some of the smartest and most talented individuals from a variety of disciplines and successfully deliver their services for many hundreds of thousands of investors around the world.

This industry will perhaps never really shake off the aura of secrecy and inevitable rumour mill, but investors and risk managers need to really start to judge funds on the metric against which the funds judge themselves:  performance.

Guest article written for AllAboutAlpha.com – the official publication of the  Chartered Alternative Investment Analyst (CAIA) Association

Originally posted at: http://allaboutalpha.com/blog/2012/04/19/finding-alpha-in-israels-emerging-market/

Since the nation’s establishment in 1948, Israel has existed in a perpetual state of conflict.  There is little doubt that these conflicts have had a negative impact on the country’s stability and relations.  The BBC World Service Country Poll states that 49% of the more than 28,000 interviewed held a negative view on Israel’s influence in the world.

This small nation has, however, experienced astonishing economic growth.  Israel is 40th largest economy in the world with a GDP of around US$245 billion (putting it ahead of Portugal and Ireland, and just behind Malaysia and Singapore).  This is a nation second only to the United States in terms of venture capital funds, with the highest rate of start-up businesses per capita and also the highest ratio of university degrees to population anywhere in the world.

To learn more about the opportunities in Israel, I spoke to Michael Freedman, Executive Director of Asquith Israel Merchant Bank.

Q: What is the current state of the Israeli Economy?

[Michael Freedman]  It’s really very robust.  Last year, while the rest of the world has been back-pedalling or stagnating, Israel’s economy grew by 4.7%.  Even this year, while many countries are worrying about a double-dip recession, Israel may still achieve over 2% growth.

Israel is really an export economy but somehow… even though the countries we are selling to are experiencing recession, they continue to want to buy the goods and services that are made here.  Israel also has a lot of room for internal growth, and we are now trying to find ways to exploit that.

There’s every reason to be optimistic… Banks here are not over-leveraged and while we have experienced a sharp increase in house prices- it’s not built on the back of individuals borrowing too heavily, it’s on the back of a lot of foreigners and Israelis returning with lumps of cash and coming into the market.  It’s for the genuine reasons that prices go up rather than because of inherently an urge to leverage.   To a degree we also experience a lot of people buying second homes here and even engaging in buy-to-let aimed (often) at the student market.

Fundamentally the economy is strong, and there’s no real reason to panic!

Q: What is the health of the capital markets infrastructure?

[Michael Freedman] There are a handful of families that own a very substantial degree of the economy including several companies on the stock exchange.  This has a couple of effects.  The positive effect is through stabilising- it’s very difficult for speculators to short stock here or to play tricks on the exchanges… there are simply not enough shares in free-float to do that.   The negative is that shares trade at a discount for much the same reasons (lower volumes).    If, for example, you are a small buyer- it’s a stable and liquid market.  If you are a large buyer, you will have to negotiate with a big group.  The government has started to take steps to address this and open this part of the economy.  Our stock market is very robust and issues of conflict are gradually being dealt with in a way that is sensitive to avoid sudden changes.

Q: Can you give us some examples of key innovations or companies which have emerged from the Israeli economy?

[Michael Freedman] There are a handful of Israeli companies who have made it onto the world stage.  You have here companies like Comverse in the tech space and companies like Teva who have become a giant in pharmaceuticals (they are now the 2^nd largest generics manufacturer in the world and have a very substantial IP bank of their own).

We are also known for a huge variety of start-ups.  Israel is not called ‘the start-up nation’ for nothing.   We have great statistics to show the number of start-ups per capita, the number of PhD’s per capita, V/C Dollars per capita, Patents per capita and more.  Israel creates a huge amount of innovative start-ups which are often bought out before they are even revenue producing!

All of the really serious players in the tech-space have really critical R&D facilities here.  Bill Gates of Microsoft is on-record as saying, “…Microsoft would not function as a company in the way that it does without operations in Israel.”  Intel also have a number of substantial R&D facilities here, and even some of their manufacturing.  Most Intel chips have two names.  The first name, which the consumer knows, is the marketing name… so you have things like ‘Centrino’ and so forth…. All the chips also have Hebrew biblical names which are the original names of the chips as they are developed in laboratories here in Israel.   Google have also now opened a major office in Israel not just for R&D but as a base to make substantial acquisitions.

Motorola have been here for many years, and a lot of the key innovations in the mobile industry came out of the businesses within this cluster.  For example, it was Motorola engineers in Israel that first built SMS into mobile handsets as part of their research into how mobile phones communicate with each other.  ICQ, the first Internet chat programme, was also an Israeli innovation.  It began with three people working out of their garage and sold out for a few hundred million in the late 90’s… a classic Israeli start-up!  The ICQ story is particularly interesting as the father of one of the boys, Yossi Vardi, later became regarded as one of the fathers of the venture capital industry.

Q: Does the Israeli security situation impact risk levels within the economy?

[Michael Freedman]  You have the same economic factors which exist in any economy.  That goes without saying…

What’s remarkable about Israel’s economy is that in the last few years we have situations which, in any other country, would have been totally disruptive.  In the last couple of months alone we have seen literally hundreds of missiles and mortars fired at us from one of our neighbours.  There is the permanent threat of having the same thing from our northern neighbours, Hezbollah in Lebanon…. And we live under the constant threat of Iran going nuclear, and what that may mean for us.   The incredible thing is that none of these threats have a measurable impact on our economy!  The defence precautions and infrastructure we have allows most of our nation’s citizens to lead pretty-much normal lives most of the time.  It’s a sad thing that a country needs to become so resilient.

For sure… if we were at total peace with our neighbours and we could afford to not spend double-digit percentage of our GDP on defence, then yes of course we could deploy that money elsewhere.  Even in this sense, we can assess the economic benefits.  A lot of the money spent on defence is spent with Israeli businesses, and from the military scientific units we are launching many start-ups!  In many ways it’s not necessarily money down the drain, but money that does create a feedback loop.

I can give you a great example of how we deal with the threat.  Warren Buffet has only bought one business outside the USA and that’s in Israel.  He bought a company called ISCAR from the Wertheimer family.  He spent US$4 billion making this acquisition which is not small even by his standards.  He was in the middle of the due-diligence process when the 2^nd Lebanon War broke out with Hezbollah.  During the due-diligence process, Hezbollah landed rockets in the car park of the main factory he was buying! Literally all the workers were in bomb shelters and very soon after they cleaned the shrapnel in the car park and got back to work.  The factory owners said to Buffet that they would totally understand if he wanted to postpone the due-diligence if he perceives a risk and he said, “…as far as I’m concerned any business that’s up and running within an hour of having mortars land in their car park is a pretty resilient company…”

Every Israeli business has built into itself the flexibility to cope with problems such as physical security threats and the fact that everybody is a reservist and could be called upon at any time to serve in the military.

Many of the costs and risks in this regard are offset by the fact that in any given group of people you will have exceptional leaders and people trained in a verity of key skills ranging from first-aid to emergency response, team-work and more.

The risks of doing business in Israel are offset by our experience in dealing with those risks, and that’s pretty unique.

Q: How is Israel’s entrepreneurial landscape and where are the investment opportunities?

[Michael Freedman]  In terms of being an entrepreneur, it’s fantastic here.  This is a country geared toward you, should you wish to start a company!  Barriers to entry are pretty low and we have a great base of intellectual property, private incubators, city incubators, not for profit incubators and more.  You name it… If you have a good idea, there are many ways of accessing capital to get your idea to the market.

The last couple of years have seen VC’s have less money to play with and so many are moving further up the food-chain.  Angel investors, who are happy to take on that level of risk and take a punt on start-ups, are filling the gap the VC’s left.  Israel are second only to Silicon Valley in terms of the power of that funding network.  The government are also working hard to attract non-Jewish entrepreneurs to come here and be a part of that story.

A really telling measure of how good we are in this regard is the fact that the UK embassy has set-up a technology hub.  This is the first time they have done this anywhere and as far as we know, this is the first time any embassy has built such a feature within it’s own walls. They have a team entirely dedicated to looking at technology transfer between the UK and Israel.  The view they are taking is that Israel is great at inventing but it then needs Britain’s engineering and manufacturing capacity together with market-scale to be the natural environment to roll these investments out.  To use the parlances they have created, they wish to link Silicon Roundabout to Silicon Boulevard!

From an investment perspective… If you are a VC or into angel investing, you can come here and literally just set up a stand in a coffee shop with a sign saying ‘looking for start-ups’ and you would have a string of people coming in all day long… you could literally sit in that coffee shop from now until next year and you wouldn’t get close to touching the sides in terms of people who want to spend an hour talking to you.  The level of innovation here is simply staggering.  If you are a more conservative investor, there is a gap in the market… Most companies here tend to sell-out before they grow particularly far or fast.  Something that more mature entrepreneurs struggle within Israel is that once they have already started-up and instead of exiting… if they want to continue running their business? It’s harder to get capital.

Israeli banks are notoriously difficult lenders (which also means they are not at risk in the current crisis!).  The nuanced private equity that we see elsewhere simply doesn’t exist here.  It’s either the heavyweight transactions or small.  The middle ground, which is very attractive in terms of risk and return, is very underfunded.  That presents an opportunity to investors who wish to come in.  That is the rationale behind our setting up… to service that need and become a platform for investors to participate, by either putting a stake directly in our fund or by investing with us in these deals.   We’ve already had discussions with major banks here such as Bank Hapoalim who are, at least at this stage, interested in investing behind us- using our infrastructure for due diligence.

It’s now been 20 years since the Yozma programme where the Israeli government pumped a huge amount of money into matching funders 1:1 should they wish to come to Israel to start operations.  Over that period, the entrepreneurial community has grown up too.  You still have the smart young kids coming out of special forces and intelligence units in the Israeli army and setting up start-ups… but you are also seeing mature serial entrepreneurs who are saying, “…you know what? I don’t want to be in a position of build it and sell it fast, I’d actually rather build an Israeli company!”

What does this mean for investors and risk managers?

Israel suffers from the fact that humans have an availability bias (meaning that we use the ease with which examples come to mind as a guide of their importance).  For Israel, this manifests with the fact that people find it incredibly hard to separate politics with economics as when they think of the nation, their mind is instantly filled with news about conflict and military exchanges.  This is perhaps, the fault of the Israeli marketing machine who have failed to promote enough ‘good news‘ about the nation globally.  There is no doubt that there are real problems concerning security and how the nation deals with religious conflict- but these are not specifically Israeli problems… countries like India and China have experienced the same with their neighbours and, like Israel, have built processes into their economy to cope.

Personally, after visiting Israel I was struck by how much opportunity exists there.  The adage of start-up-nation holds true, with a real spirit of entrepreneurship and development from central government right down to individuals.  The businesses created are typically IP rich and with Israel’s solid export credentials the opportunities for growth are significant.

I would certainly urge investors to consider Israeli firms in their portfolios.

It’s Time to Get Business Spending

In March 2012, The Economist reported that UK corporate surpluses reached more than £700 billion last year, amounting to almost 6% of GDP. The United States told a similar story with the 1,100 non-financial corporations rated by Moody’s showing cash balances of over £1.24 trillion (almost 10% of US GDP)… and in Europe, a group of 30 larger cap non-financial corporations (as at June 2011) were sat on over $872 billion (around 7.2% of European Union GDP).

There are a constellation of reasons why firms are hoarding their cash, but a few key ones are:

1.  Economic Sentiment:
   There is no doubt that firms of all sizes are viewing the economy as being very uncertain and potentially precarious.  With such sentiment being widespread, firms are much less likely to invest in assets (which may decrease in value) or projects (which may fall victim to economic volatility).  The poor perceived outlook on consumer, corporate and institutional spending (across most global territories) also makes firms considerably less likely to engage in expansion strategies.
2. Tax & Policy:
   Entrepreneurs and CEO’s are genuinely worried that firms are going to face years of increased taxation to pay for the unprecedented economic stimulus.  Alongside this one must also factor in the ‘risk value‘ of cash.  Businesses operating in a riskier environment will inevitably want a higher return on the capital they deploy.  In most developed countries however, the marginal increases in taxation have yielded a disproportionate ‘flight to safety‘ where firms end up hoarding their cash balances against forced redistribution. A less discussed but equally significant phenomenon has been a gradual erosion of faith in central governments and their policies. A well functioning economy requires that entrepreneurs, firms and other stakeholders place trust in their political leadership to not only support them- but be consistent in their approach.  One business advisor I spoke to said he finds it very hard now to fathom, “what on earth they [referring to government] will do next…“.
3. A Lack of Investment Alternatives:
   Private sector cash balances are not a new phenomenon within the economy. The new aspect is behaviour.  These cash balances were often plugged into a wide variety of financial instruments (such as equities, funds and more) which typically gave near cash-like risk profiles with a reasonable return.  Such instruments are now lacking as even previously robust classes such as sovereign debt and large cap equities now carry more risk than most corporate treasury managers would like to hold without a corresponding return.
4. Hidden Deficits:
   The profligate spending of the past 25 years has also left a tremendous amount of firms worried about structural deficits which may be created through gaps in pension fund obligations and even gaps in the value of hard assets.  Many larger firms in particular are holding cash-balances on reserve to cope with these eventualities which could easily prove fatal otherwise.  To put this in perspective, the US Private Sector is estimated to be running a pension deficit of over $420 billion.

What’s the Problem?

Instead of looking at hoarded cash as being a ‘rainy day fund‘ we need to view these balances as stores of economic growth.  This cash represents potential investments, new jobs, new innovations and the potential for significant wealth creation and diffusion.  So how can we get firms spending again?

1. Quantitative Easing… but not as you know it…
   ‘QE‘ worked to the extent that it cleansed the balance sheets of many financial institutions and did, to a degree, push cash into the equity markets.  The problem is that quantitative easing injected cash to buy high quality assets (gilts and corporate paper).  In reality, the institutions who now hold the fresh cash are often unwilling to take risky debt onto the balance sheets meaning that at the coal-face firms may not be getting the benefit.  Governments have a unique ability to aggregate and de-risk.  Using a bank of recovery model the government and banks could aggregate their risks into a lending pool which directly funds the businesses who need the cash the most.
2. Incentivise things that aren’t cash…
   Rather than lowering the value of cash (and thereby hitting savers hard) governments should really apply better incentives for those who want to invest in the constellation of instruments that aren’t cash.  Maybe give better tax-breaks for investing in small business, maybe give a lower capital gains rate for certain classes of equity, or maybe give much clearer tax benefits for firms who wish to invest in growth.  Governments may even be able to create a shadow lending rate for businesses based on long-term gilts.
3. Incentivise Business Activity…
   Incentivising business means incentivising entrepreneurship and celebrating wealth creation.  Many governments, faced with a popular revolt, have chosen to martyr wealth without realising that it is the source of entrepreneurship, innovation and philanthropy in their economies.  Entrepreneurship is at the very heart of any development discussion- principles which we hypocritically apply to emerging economies without applying them to our own.
4. Incentivise Hiring….
   People are pretty close to being the single most important asset a firm can have.  Many businesses I speak to are often reluctant to hire for reasons that may surprise you.  In many cases, they simply do not want the additional compliance headaches and in many cases they are scared of litigation should they need to let people go…  Our employment law and employment regulations are in drastic need of updating to ensure they not only best represent the interests of the employee and the employer, but also to ensure they streamline and de-risk the hiring process.
5. Change the Story…
   People sometimes underestimate the role of the media in our economic story.  Human beings have a tendency to generate availability heuristics meaning that we give increased importance to things we can recall quickly.  When assessing the economy, it is far easier to recall stories of doom and gloom than positivity.  It’s time to change the sentiment, and that means changing the story.

The developed world economies have a tremendous amount of positive attributes.  We have an extremely skilled labour force, fantastic infrastructure (physical, economic and political) and a very mature capital market.

The world of business is scared without realising that it, itself, is the cure.

In 1919, a man started a small business selling surplus groceries from a market stall in East London.  His first day’s sales were £4, giving a profit of £1 (around £178.00 in sales and £44.00 profit in today’s money).  Fast-forward around 90 years and this business now generates over £50 billion in annual revenue, employs around 472,000 people worldwide and generates £6,000 in profit every single minute of every single day.  This business is TESCO Plc.

With very few exceptions all of the largest companies in the world started life as small businesses which, through a supportive economy, access to the right people and- of course- capital, turned into giants.  In practice it’s a very small percentage of small firms who experience this kind of growth but the fact remains that small businesses (as a group) remain critical to the UK economy, providing over 67% of the UK’s private-sector jobs and contributing over 50% of UK GDP.

To learn more about the importance of SME’s in the UK economy, I spoke to Professor Mark Hart of the Economics and Strategy group at Aston Business School.  He jointly manages the Global Entrepreneurship Monitor (GEM) project in the UK and advises a number of Government Departments on SME matters including BIS, UKTI, HMT and HMRC.

Q: What is the role of SME’s within the UK economy?

[Prof. Mark Hart] They’re pretty crucial.

It’s clear to me that small businesses, particularly micro-enterprises, have been responsible for the majority of the gross job creation in the last five years… particularly through the recession.

I’ve also done some research on mid-sized businesses (or mid-caps as they are increasingly known). These are typically businesses with £25-500 million in turnover and they are shedding jobs!  Whilst there is a lot of policy interest from the CBI about these (larger) mid-sized companies, I prefer to look at the small business sector as an engine for jobs growth.

There is a question over the extent to which they [Small Businesses] are driving wealth creation and productivity in the economy, but in terms of jobs at the moment- it’s clear that these business are vital.

In terms of productivity drivers, there is a large contribution to be made by small businesses, specifically those who are involved in sales to international markets.  We also know from research that high-growth firms, many of which are small businesses, are crucial in terms of driving innovation – although there is a complex two-way relationship between growth and innovation.

Q: What are your views on confidence within the SME market?

[Prof. Mark Hart] Through the recession, in my work with the Global Entrepreneurship Monitor, we asked businesses owners the question, “do you think there are good opportunities for doing business?”

We asked that of new and established entrepreneurs and found a consistent profile whereby 1 in 10 business owners felt that there were opportunities in the midst of recession!  That’s a significant number, albeit not a majority.

There is however, a lot of concern in the sector that not enough is being done to support them, which has knocked business confidence.  If you’re selling in the UK marketplace to businesses and consumers, you are faced with an economy that is flat lining, which is also making things difficult.

Q: Are there any key challenges facing SME’s?

[Prof. Mark Hart] For every example I could give you of regulations causing problems, I could give you two of regulations creating opportunities.  I think this notion that regulation is causing problems is a real red herring.  The vast majority of business owners know when they set up a business that they must comply with the regulatory frameworks that exist.

I think the challenges are about getting the right people in business, and… of course… finance.   It’s important to note that in the main, established businesses that are on top of their finances, who are clearly able to articulate their needs, and can demonstrate that they are commercially viable… will get the finance they need.

Q: What could the UK do to stimulate more SME entrepreneurship?

[Prof. Mark Hart] For me, one of the big gaps is youth entrepreneurship.  There are a high number of young people who want to set-up businesses, but there is a huge gap between their aspirations/intentions and the actual delivery of setting up a business…. More so with the young than any other age group.

That gap is about skills (which are easily gained), confidence and access to finance.  If you’re 18 and you have a business idea and your family doesn’t have a legacy of business ownership behind them it’s more difficult for you to articulate to a bank or lender that you should get the money you need.  Communities have a role to short-circuit that through, for example, loan funds in communities.  Raising capital for those initiatives can however, be very difficult.

There is also an agenda for older age groups.  I am a trustee of PRIME which is the Prince’s Initiative for Mature Enterprise.  We see that levels of entrepreneurship in the 50+ category are lower than other age-groups but there are a lot of people there who want to come forward and set up businesses.  Many have been made redundant, many want to do it as a lifestyle change… and I think support for those people isn’t as developed as it could be.

The issue for me is that whilst we have all these schemes to bring forward start-ups into the marketplace, there’s huge churn.  Yes the micro-enterprise sector creates jobs.  The established micro-enterprise sector creates around a 1.5 million jobs each year, which is a big number.  In terms of start-ups, we were getting around 1 million new jobs created every year (excluding self-employed people).  That’s fallen to around 600,000 in the recession.  We have to control this churn, and make sure that the most competitive businesses survive.  It’s a bit of a lottery in many ways.

We have to be careful about just increasing start-up activity.  If we are increasing the level of start-up activity of people who are more inclined to employ other people, fine… but I’m not convinced that is the case.

Q: Are there any sectors of entrepreneurship in which you think the UK is particularly competitive?

[Prof. Mark Hart] Believe it or not, we do have a very strong engineering base.  In the West-Midlands where I am based, I am astonished by the level of strong engineering skills in manufacturing companies and in their supply chains.  We really have to build on that.  People talk about the green and low-carbon economy.  These are perhaps fanciful terms, but underneath that, there are solid engineering and manufacturing companies.

I’m very old-fashioned in the sense that I still feel you need a strong manufacturing sector in your economy.  I was saying that in the late 1970’s and early 80’s and people just laughed at me.  I think my day is about to turn.  In the Midlands alone we have over 1000 small manufacturing companies being set up every year.  A lot of them are micro-businesses in a whole range of manufacturing sector.  That tells me that there are skills out there that allow people to set-up businesses, quite easily, that turn over £300-400,000.  The major problem for them is finding skilled labour to bring into their businesses.

———

Enterprise exists at the very heart of every economy and the UK is no exception.  Entrepreneurship provides a nation with employment, wealth, innovation and development.  It funds culture and provides a redistribution of money into an economy to help those who need it more.   Astonishingly most of these enterprises are smaller than you may think.  Of the 4.8 million businesses in the UK, 96% employ less than 10 people; 74% of those are ‘size zero’ businesses (i.e. those who have no employees such as sole traders).

Never before has there been a better time to start a business.  The amount of support from government, enterprise and the not-for-profit sector for emerging entrepreneurs is now at the highest level in history.  Our nation depends on these business owners to continue supporting the economy into the future.

As Benjamin Franklin himself said, “…No nation was ever ruined by trade.”

In this exclusive interview, we speak to Yury Fedotov (Executive Director of the United Nations Office on Drugs and Crime, UNODC). We discuss the scale of global crime looking at issues ranging from drugs and drug trafficking to money laundering, corruption, violence and even the illegal trade in human beings themselves.

http://thoughteconomics.blogspot.co.uk/2012/03/true-scale-of-global-crime.html

Guest article written for AllAboutAlpha.com – the official publication of the  Chartered Alternative Investment Analyst (CAIA) Association

Originally posted at: http://allaboutalpha.com/blog/2012/03/29/alpha-hunter-lauren-templeton-on-generating-alpha-from-value-investing/

Value investing has been a successful strategy for many investors since the earliest days of equity markets.  The principle is quite simple.  Investors select stocks they feel are trading for artificially less than their intrinsic values and hence are (significantly) undervalued by the marketplace.

Sir Jon Templeton was a pioneer in this field  He began his career on Wall Street in 1937 and went on to create some of the world’s largest and most successful international investment funds.  In 1999, Money magazine rated him as, “arguably the greatest global stock picker of the century…“  He sold the Templeton Funds in 1992 to the Franklin Group for $440 million, and today his great niece Lauren Templeton continues the legacy through her firm, “Lauren Templeton Investments“.  Ms. Templeton is the president and founder of the Southeastern Hedge Fund Association, INC and is a Trustee of the Baylor School and the Finance Advisory Board of the University of Tennessee Chattanooga alongside which, she is a member of the Templeton Foundation.  She also co-authored “Investing the Templeton Way: The Market Beating Strategies of Value Investing Legendary Bargain Hunter“.

In this interview, Ms. Templeton takes us through her story of generating alpha from value strategies.

Q: What are the key reasons for some stocks becoming “bargains”?

[Lauren Templeton] We tend to see two scenarios that come up time and time again.

The first and most common scenario is that security prices become inefficient or show large departures from intrinsic value when there are few investors paying attention to the company.  So in this case, we are talking about a neglected stock.  One good example is the recent take-over of NEO Material Technologies which is our company’s largest holding.  They are a rare earth refiner who are listed and headquartered in Toronto, but they have substantial operations in Mainland China near their primary source of rare earth.  China controls 90% of the world’s supply of rare earths and do not, in general, allow foreigners to participate in ownership of that supply.  NEO Materials however, has managed to set-up operations in China near the main source.  This company we purchased back in 2006/2007 had little (if any) research at that time, but was remarkably well positioned in the value chain for rare earths insofar as it had competitive advantages in the processing of rare-earth materials.  It had very high operating margins and high returns on capital to illustrate those advantages.  Back then… before rare earths became popular as an investing topic, the company was trading at just 6x earnings! The reason we believe for this is that nobody was paying attention to it!  Since 2006/2007, rare earth prices have really increased.  NEO Materials can pass along these price increases and so the stock’s valuation increased, as did research coverage.  That’s a great example of a neglected opportunity.

The second is a crisis situation.  This can occur in a country, a region, an industry or a specific company- and we take advantage of all of these. Uncle John always had a desk-plate in his office that said “trouble is opportunity” and that’s very much how we see the markets.  A great example of this would be the Swine Flu crisis of 2009.  That crisis really hit home for me because my daughter was born in March of that year.  My husband and I had just come out with a book, “Investing the Templeton Way” and we had been the opportunity and do the annual book signing in conjunction with Berkshire Hathaway.  This was such a good opportunity, but we had a 6 week-old daughter that we were going to have to travel with.  I was a first-time mum, and scared-to-death as Swine Flu was all over the news!  People at Berkshire Hathaway were walking around with facemasks and Vice President Joe Biden said he wouldn’t fly on an airplane.   On the other side of the coin, I remember coming into the office and saying, “how are we going to play this?….”  We started research doing screens and ended up identifying Mexican Airport operators who were already trading at cyclical lows.  They had already declined over 20% in a single-day because of this crisis.  They had EBIT margins ranging from 30-40% and were great businesses with little to no debt.  We bought three of these firms, taking a basket approach.  All were very profitable, and we later collapsed them into one position that remains in our portfolio today.   Whether it’s Swine Flu, the Japanese Tsunami or any other crisis, we’re out there looking for an opportunity.

Q: How do you determine the “point of maximum pessimism”?

[Lauren Templeton] The point of maximum pessimism is the ultimate time to buy a stock because at this point, all the sellers are gone… and only buyers remain.   How do you determine this point? Even Uncle John said it’s impossible…. You never know until it has passed!

For us, it is best signalled by valuations that are creating new lows versus historical valuation levels or relative to other stocks.  That’s when we get the most excited! In late 2007/09 PE ratios across the market were as low as they had been in 25 years.  That was exciting to us because at some level we felt like we had our choice of stocks to purchase which… as any investor knows… is a rare luxury.

If you had to perform this exercise on a company like AGCO which was one of our holdings during the financial crisis, or Agrium which is one of our current holdings… you would have found that the market was discounting low single digit growth into perpetuity!  You would have had to ask yourself whether that was reasonable…. For us, it wasn’t reasonable in these stocks.  We believed that for these organisations there were opportunities in agriculture from emerging market consumers; and so we decided that single digit growth rates were unrealistic for this industry.

Q: How does your valuation methodology work?

[Lauren Templeton] Our methodology is pretty simple. We start out by looking at standard quantitative screens that we have used for many years.  There’s nothing sophisticated about them, they are standard valuation screens that most investors would use.  Once we run these screens, we focus on the bottom decile of the list.  If we find interesting companies we feel do not belong there, we will run them through a discounted cash-flow model to get their intrinsic value over a 10year view.   We will not employ capital unless we can find an opportunity that has a minimum of 50% upside to our intrinsic value over the term of our investment.  While we project over a 10 year period, our target holding is 3-5 years.

In terms of selecting companies, we look for companies that are growing faster than their peers… have higher operating margins than their peers… and have higher return on capital than their peers.  In currency, we pay attention to purchasing power parity and favour currencies that appear under-valued.  Right now this would be currencies like the South African Rand, the Chinese Renminbi and more.  There are also examples of currencies which are very well managed by their governments and are unlikely to lose value over time such as the Canadian Dollar.

Our sell discipline is that when a company or stock approaches our approximation of intrinsic value, we liquidate the put position… quickly if it’s a cyclical company.  This yields cash into the portfolio.   Typically you will

have a few stocks, all at once, approaching your estimations of intrinsic value.   If the market is fair to over-valued, it will be more difficult to find these opportunities and this process will really slow down.

Managing a hedge fund as a value-investor is a dream come true!  Uncle John managed a mutual fund… in this industry people give you money at the wrong time, they take it away at the wrong time… and although they do that in a hedge fund as well, monthly versus daily liquidity curbs it a little bit.  Hedge funds also have two additional levers I can pull which mutual funds cannot access.  Firstly, I can start covering shorts meaning my net long exposure goes up.  The second is employing leverage.

Q: To what extent do you think human behaviour can lead to mispricing in the market?

Sir John Templeton reading the Wall St. Journal at the North Pole

[Lauren Templeton] To a huge extent!

Behavioural finance and value-investing are perfectly compatible.  Human beings have a real tendency to overreact on the upside and the downside.  We are not rational investors.  I do not believe that people make rational financial decisions!

If you study financial decision-making you will find that human beings are irrational in a very predictable manner.  Most theories in finance such as modern portfolio theory and so forth are based on the existence of ‘homo-economicus’ which models man as a perfectly rational wealth optimiser.  In the real world, evidence suggests this simply is not the case.  We make the same mistakes over and over again, and behavioural finance experts refer to these mistakes as biases and heuristics.    I as a value investor focus on the social side of this… herding, contagion and so forth.   These opportunities allow me to compound money at a higher rate than my peers simply because I’m taking advantage of these mispricing events.

Uncle John’s career really blossomed late in life.  He sold his business in New York, and the one thing they didn’t buy was the Templeton Growth Fund.  He and his wife moved to Nassau in the Bahamas and he was stuck with the Templeton Growth Fund!  He managed it from there and it really made his career.  He told me that his returns got so much better in the Bahamas, why? Because he got the Wall Street Journal a few days late!  It’s so difficult to mentally distance yourself from the herd and so perhaps physically distancing yourself from the herd is a good idea.

I genuinely believe that you can train yourself to see trouble as opportunity and realise that the best time to make money is when other people are most fearful.

What does this mean for investors and risk managers?

The world of investment continues to seek ever more sophisticated methodologies to seek opportunities in the marketplace.  Lauren shows us that value investing can yield significant opportunities for return in the market by using very well established principles and solid fundamentals.  Her view is a necessary breath of fresh air in an environment where otherwise complexity has been king.