Joseph Lee

November 19th is management pioneer (now deceased) Peter Drucker’s 100^th birthday. To celebrate the life and teachings of this remarkable man, the Drucker Institute hosted a weeklong event, Drucker Week, featuring some of the most respected business academicians (a paradox?) of the world at Claremont University.

Ken Blanchard (author of The One-Minute Manager and Know Can Do!) was there, along with Warren Bennis (author of Judgment), Stephen Covey (author of The 7 Habits of Highly Effective People), Charles Handy (author of The Gods of Management and Myself and Other More Important Matters, Frances Hesselbein (co-editor of the Drucker Foundation’s three-volume Future Series and Leading Beyond the Walls, and Jim Collins (author of Good to Great)—real heavyweights.

Here is a short account of my experiences attending this notable event:

On Tuesday, November 4^th, Ken, Warren, and Charles entertained a downtown Los Angeles crowd at Club Nokia. Ken spoke of the need for the servant leader—someone willing to put himself at the bottom of the organization chart (an upside down pyramid)—to support those closest to the customers. After all, as Peter Drucker said, the only purpose of a business is to create a customer.

Charles Handy told the audience that this opportunity to talk about Peter Drucker was a great chance for him to learn—for what better way is there to learn than to teach another person what you know? He also challenged the MBA programs around the country to offer classes that will more properly mirror the demands of the business world.

Warren Bennis remarked about the need for leaders to show respect, the starting point for all forms of communication. All three speakers hit home on themes that Drucker had promoted—the customer, the importance of the human element, and the social purpose of any organization.

On Saturday, November 9th, Jim Collins was the featured speaker. Powerful and eloquent, Jim walked us through his thoughts on Peter Drucker and pointed out that for Peter, his next book was always going to be the best; at age 65 he was only a third of the way through the 39 books that he would ultimately write. He urged students to form their own “board of mentors” who would advise them throughout their careers. Widely viewed as the “Drucker of the 21st Century,” Jim was at times teacher, then philosopher, but perhaps most importantly, a master communicator.

Prominent Japanese businessman Masatoshi Ito had a friendship with Peter Drucker that lasted decades and culminated in the naming of The Peter F. Drucker and Masatoshi Ito Graduate School of Management at Claremont University. I’ve known Mr. Ito for ten years and had the opportunity to have lunch with him on Saturday. Originally, we had planned a quiet lunch to include his son, Yasuhisa, in Claremont. However, I was told of a change in venue on the day of the event:

“Mr. Ito wants to have In-N-Out Burger.”

And so, we ended up at the storied West Coast fast-food chain.

Mr. Ito is one of the most respected business leaders in Japan.  He is 85. His curiosity for knowledge, his desire to learn, and his eagerness to experience everything first hand—these are the traits of leadership that have kept him sharp. Upon arrival, he walked in, looked up at the menu and asked, “What is the best selling item on the menu?” (The Number 1—a Double-double with soft drink and fries, according to the guy behind the counter).

We spent the next 45 minutes talking about the speakers, what they represented, about society, and about the future of the US and Japan. We talked about Covey, about Collins, about Rick Warren (founder and senior pastor of the megachurch, Saddleback Ranch), and about Blanchard. We talked about In-N-Out Burger and its business model. He asked probing questions. And then he listened.

Drucker Week was a special week. We heard Drucker’s words through great speakers such as Collins, Blanchard, Covey, Handy, etc. But for me, the final word I heard from Mr. Ito would be the one that remains in my memory.

“Oishii…”   (Translation: Yummy hamburger)

Joseph Lee is an adjunct professor at the Graziadio School of Business and Management and Peter Drucker & Masatoshi Ito Graduate School of Management, where he teaches a course on management consulting. Read his blog at joe-lee.com/blog.html

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Dean Linda Livingstone, Winner Kasra Ferasat, GBR Editor-in-Chief Owen Hall

Kasra Ferasat of Palos Verdes, CA., (pictured center) a fully employed MBA program student at Pepperdine University’s Graziadio School of Business and Management, is the 2009 first place $1000 winner in the student paper competition held by the Graziadio Business Report. For the second year, the publication has invited Graziadio School students to submit articles and compete for the chance to be published and for a cash prize awarded by Dean Linda A. Livingstone (pictured left) and Editor-in-Chief Owen Hall, Jr., a professor of decision sciences (picture right).

Mr. Ferasat’s award-winning composition presents five recession-fighting tactics that must be incorporated into a restaurant’s overall strategy in order to maintain a competitive advantage. The restaurant business is facing its worst time in 40 years with fine-dining restaurants expected to decline by 12 to 15 percent, he writes.

How can restaurateurs create and maintain a profitable business while adding value, increasing sustainability, and providing fresh food for the consumer? Consistent food service, food quality and safety, embracing technology, marketing, and creativity are solutions addressed in the article, available at gbr.pepperdine.edu/094/studentpaperwinner.html, in the Fall 2009 issue of the GBR.

Restaurants fail all too often because passion takes over strategic vision.

“Passion is important, but it can blind a restaurateur to the important issues at hand,” Ferasat said. “A restaurant must incorporate the same value propositions given to a (commercial) product or service to enhance its future growth.”

Ferasat credits his curiosity about the food business with his extensive travels and his. interest in culinary traditions around the world. He believes the food industry needs young managers to help develop healthier and more sustainable food businesses.

Ferasat is an MBA candidate concentrating in marketing and entrepreneurship at Pepperdine University’s Graziadio School of Business and Management. Presently, he is a realtor with Merit Real Estate, a full-service real estate firm in Redondo Beach, California. He has experience in several industries, including international freight forwarding, private equity, and import/export. Ferasat received a bachelor’s degree in international relations and global business from the University of Southern California. He completes his Pepperdine degree in summer 2010.

For information on the 2010 Student Paper competition, visit gbr.pepperdine.edu/studentpaper/2010.html.

Davide Accomazzo, MBA

In my many years as a derivative trader and hedge fund manager, I forged a solid and long-lasting relationship with risk. Like a beautiful but dangerous woman, risk permeated my professional life—a constant courtship leading me to many attempts at fully understanding its mysterious ways. A never-ending effort!

The theoretical foundations of risk analysis were laid in business school where I diligently learned of Alpha and Beta, Random Walks and Efficient Market Hypotheses (EMH).* These theories were elegant and pure, like a fresh mantle of snow they seemed to perfectly cover all market uncertainties and provided a boost of confidence to a young man ready to leave his mark in Wall Street.

Yet the one reason why I was fascinated by the markets was the mesmerizing and intellectually challenging example of hedge fund manager extraordinaire George Soros. His book,The Alchemy of Finance, seemed to directly contradict EMH and his highly successful track record was damning evidence. Nevertheless, one of my first large successes came from the application of the bell curve to index returns for an option strategy. It worked like a charm in the roaring late nineties.

This initial success aside, every night I could not shake off that feeling of disconnect from theory to practice. Yogi Berra once said: “In theory there is no difference between theory and practice, in practice there is.” Indeed, while the EMH trading model was successful, the distribution of returns seemed way out of line with even a fat tail distribution. Adding to my discomfort was the clear pattern of price dependency upon past changes (the H factor as Mandelbrot defines it) versus the theory of price randomness.

In 1999 and in 2000 we witnessed a ridiculous bubble in internet and technology stocks and a consequent blow up—a dynamic that really should not have happened in the EMH universe. During 1999 I had decided to tweak my model and added heavy behavioral components. I think such changes saved me from terminal disaster in 2001, 2002 and more recently 2008.

In spite of evidence of misleading logic and cracks in the foundation behind the concepts of Beta and EMH, the theories are still wildly popular among academics.

Academic politics and group thinking may be the cause; after all, almost every economist in the country is one way or the other on the Federal Reserve payroll for example. Yet Beta and EMH are now under attack not only by behavioralists but by mathematicians as well. Benoit Mandelbrot, one of the most influential mathematicians of our times, is very vocal—he started his critique 40 years ago and was derided by the mainstream—against these alluring but ultimately deceiving theories. Paul Wilmott, author of several books on quantitative finance, has also been active in his criticism.

The idea that equity returns are random and therefore should be expected to fall in line with Gaussian distribution models is a bizarre conceptual starting point. While many natural events follow such distribution, why would something like investment returns follow a statistical order? Aren’t stocks prices the result of fear and greed? Aren’t financial markets the making of highly emotional beings? Isn’t information asymmetry a major issue in financial markets? If anything, a clean statistical distribution should have been a last resort explanation for price formation rather then a starting point.

The real world does not move neatly—markets are messy and simple mathematical relationships cannot capture reality.

Equity prices can be explained by more logical (yet less statistical) structural and behavioral relationships. The Capital Asset Pricing Model armed with the false fortitude of the bell curve, reduces everything to one variable, Beta, to explain risk. But does one variable for a system as complex as financial markets make sense?

The buy-and-hold theory forced stocks in people’s portfolios even when valuations were clearly off on the assumption of a consistent equity risk premium. This dynamic snowballed into the commercial explosion of beta-driven portfolios and unhooked Wall Street from any effort to produce intelligent analysis. Portfolio management reduced its legal liabilities and turned the large majority of the asset management universe into a huge marketing machine sucking in money flows which perpetuated the fallacy.

Beta is dead—long live Beta! Or perhaps it never existed.

Maybe Beta was just a mirage of an industry looking for order and economies of scale. In the end, however, investment returns were proven to be influenced not by statistical distributions but by real issues.

Financial markets are highly reflexive as George Soros pointed out 25 years ago, and as a result, equity prices are dependent on the past. Momentum is a constant component of price formation. Also, the structural dynamics of the money management business are clearly heavy influencers of stock prices—the heavy hand of relative performance among money managers and the problem of career and business risk are two of the most important influences in the process of pricing investments. Tax issues and the changing regulatory environment are certainly more important drivers of prices than the Gaussian distribution. Not to mention social contagion, feedback loops, and of course changing technology.

The smart money manager must rely on a much more sophisticated framework than just the bell curve. I like to approach my investments following a 4-level framework (ex-hedge fund manager turned media entrepreneur Todd Harrison follows a similar approach):

• Structural overview: An analysis of the political, regulatory and technological environment.
• Fundamental overview: Valuation analysis such as Cyclically Adjusted Price/Earnings ratios and others.
• Technical market make-up: Momentum, mean reversion, support and resistance, volatility.
• Sentiment overview: A comprehensive behavioral analysis.

Comprehension of financial markets and the risks they inherently breed is a never-ending process. As elegant as Beta and EMH were they were clearly not the answer.

*The following has been provided by the author to aid the reader in grasping the content of this post. It should by no means be considered a comprehensive overview of contemporary financial models.

Modern Finance and Modern Portfolio Theory began with the idea that stock returns are statistically distributed like most natural events, for example human height and weight follow a Gaussian distribution where 68% of samples are within one negative or positive standard deviation from the mean and 95% of samples are within two standard deviations. Such statistical distribution is shaped like a bell, therefore the name “bell curve.” However, equity returns were exhibiting some anomalies and unexpected values; three standard deviations or more from the mean were much more frequent. The term “fat tail,” indicates the thicker tail end of the bell.

This concept is at the heart of modern finance. Inspired by this idea, Princeton professor, Burton G. Malkiel, wrote extensively about the random walk of earnings. He believed that earnings, and therefore stock prices that reflect those values, were completely random and therefore impossible to consistently forecast correctly. Of course, in order to believe in the previous two ideas (randomness of returns and randomness of earnings) one is to believe that all data samples are independent of each other, just like multiple tosses of a coin.

This approach to equity markets also relied on the assumption that markets participants are fully rational and base their decisions on past observations and by holding rational expectations for future outcomes. Rational portfolios are then constructed based on normal statistical distributions.

Nobel Prize winner Harry Markowitz wrote extensively on Modern Portfolio Theory and perfect market portfolios. The concept of Beta was a natural evolution of Markowitz’ thought process and indicates the statistical relationship between a stock (or portfolio) and the general market. Beta is an idea that eventually ties with the Capital Asset Pricing Model, a tool to price assets based on the risk-free rate, the market risk premium, and the beta factor.

The Efficient Market Hypothesis is the box that holds it all together. If we assume that all market participants are rational and if we believe that all data points are independent and normally distributed, it is then reasonable to expect markets to be very efficient and capable of pricing assets at fair value. In this efficient universe, markets clear all available information and price it instantaneously and market prices are never far from fundamental values.

Sources:

Benoit Mandelbrot, The (Mis)behavior of Markets, Basic Books, New York, 2004.

James Montier, “Insight: Efficient Markets Theory Is Dead,” Financial Times, June 24, 2009.

George Soros, The Alchemy of Finance, Wiley and Sons, 1994.

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Joetta Forsyth, PhD

I recently had a bad encounter with a bank. However, there is a basic principle that I follow that kept me from financial harm.

I applied for a business credit card, which I wanted to facilitate payments and I intended to pay off each month. It was a little late in the day and the person who handled business accounts had left. Another person at the next desk over offered to “help” me.

I explained that I wanted to take out a business credit card and gave him my business checking account ATM card, which he used to look up my account. He told me about a “great deal” on a card — I wouldn’t have to pay fees to get the frequent flyer miles, etc.

I told him that I was confused because I had called the bank and they did not tell me those terms. His reply, delivered with a beaming smile, was that it was a special offer only given in person. I asked to see the terms and conditions, and he told me that they would be mailed to me after I applied for the card. I had to ask twice more. I flat out refused to apply for the card without seeing the terms and conditions first. He finally gave up and went to print them out. I told him I would read them and come back the next day. At home, I discovered that the right side of the print out was cut off and I couldn’t even tell what it said.

The next day I came back and met with the person handling business accounts. I told him that I couldn’t read the terms and conditions. At this point I found out that they were for a personal credit card. Had I unknowingly been issued this card that I didn’t want, my credit record would have taken a hard hit, lowering my credit score.

But much worse, if I hadn’t realized it was a private card and used it, I could have gotten in trouble with the IRS for trying to deduct any expenses on the card as business expenses. In addition, it might have caused my Limited Liability Company problems. Businesses owners can have their limited liability protection stripped from them in a law suit if it is found that the owner comingled their business transactions and personal transactions.

I was appalled. Had the person who tried to issue me the personal card intentionally deceived me? If so then why? My only guess would be that they were in charge of personal cards, and wouldn’t have gotten a commission on a business card. Hence, their attempt to intercept me and steer me into a personal card.

The alternative explanation is incompetence. What sort of banker doesn’t know the difference between issuing a personal card and a business card? Worse yet, for years the bank had dealt with me in an ethical way. Has the financial crisis gotten so bad that “it’s every banker for himself” and abusive behavior is the now the norm? I know that this particular bank is feeling strains from the financial crisis.

My experience only serves to demonstrate an important principle that I teach — ALWAYS READ THE FINE PRINT. Many people are uncomfortable asking, because they feel that they are questioning the other person’s integrity. This is simply not true. Pluck up your courage. You are not being rude when you ask. Any loan officer, mortgage broker, etc who discourages you from reading the fine print is in the wrong. They are behaving badly by discouraging you from understanding what you are signing, when it is only prudent and reasonable for you to do so. Stand tall and demand your rights!

Related in the GBR

• Investing for Income in a Down Economy by Steven R. Ferraro, PhD, CFA
• Learning to Love Financial Market Barbarians by Joetta Forsyth, PhD
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Nancy Ellen Dodd, MPW, MFA

I have been teaching with Frances Grimes in the Management Communications program here at Graziadio this fall and so business communication is on my mind.

Face-to-face business communication is difficult—attempting to read body language, facial expressions, and gestures (although some gestures speak for themselves), can be a challenge. Not to mention cultural differences that can blur the meaning to any one or all of the above.

Even more difficult can be written communication when there are no expressions and gestures to guide us. Add poor grammar, haphazard punctuation, and misspellings… well, we all know where that can lead. Then mix in the language of different cultures and disciplines, and you can really have a problem.

I once wrote an email to someone in another department who was handling our IT. Since we were just starting to develop audio and video, I needed extra help with a particular project. In the email I wrote that I just needed a download of the file in a new format for “audacity.” The recipient of the email responded not quite in the way I expected, offering to do something quite different than I requested.

In a brief conversation in the hallway, I later learned that as a non-native English speaker this person was a little hurt by my accusation “of having the audacity to attempt to make changes.” I had not capitalized the word “audacity” nor explained that Audacity is a software program I was using to edit audio, thus the miscommunication. I learned to consider my audience in writing an email and to always ask, “Is what I’m saying in the correct context for the recipient?”

Here are a few tips to improve your email business communication:

1. Briefer is better. Be simple and direct. You are not writing a paper for school or an academic article; you are trying to get information “to someone” or “from someone.” Make sure you state clearly and succinctly what you want and when you need it in as few words as possible, while still giving essential details. Use bullet points for details that you can list.
2. Good grammar and punctuation are key. A comma in the wrong place can change the meaning of what you are writing. Not using proper capitalization can confuse the importance of the subject. Poor grammar shows an indifference to the topic and is demeaning to the recipient of the email, but more than that, it diminishes the perceived intelligence of the author.
3. Load the important information at the beginning. Too often people only read what they see in the email window and ignore that there might be more. If they scan the email and the important information is at the end, it may not be captured in their quick scan. How often have you heard, “You didn’t say that!” when you did—buried three lengthy paragraphs later.
4. Read it over. Change the word choice to precise language and listen for whether the words sound angry or indifferent or silly. The more important the topic, the more attention should be paid to the tone. Does the email sound stern or friendly, insulting or even angry. BY NOW, EVERYONE SHOULD BE AWARE THAT TEXT WRITTEN IN ALL CAPS IS CONSIDERED SHOUTING.
5. Which leads to the final tip: Don’t hit send until you’re absolutely ready. Once an email is sent, it is out there somewhere in the ether. Have you ever hit “Send” and immediately regretted it? Although some systems have a “Recall” feature, it does not always recall all the emails. Sometimes therapists suggest writing a letter and letting all your feelings out, but then not sending it. Whatever you do, do not do this in an email. Use a paper and pen so that it is a little harder to send. And when you reply to emails, take a moment to consider whether you mean to hit “Reply All” or “Reply” or even “Forward”—big differences with potentially very embarrassing consequences for clicking the wrong one.

Have your own email writing tips or stories? Share them in the comments!

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Editor’s Note: A Lexicon of Business and Information Technology (IT) Acronyms by Nancy Dodd, MFA, MPW

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Can’t see the above video? Click this link to watch.

In this video interview, David M. Smith, PhD, Associate Dean of Academic Affairs and Associate Professor of Economics at the Graziadio School of Business and Management discusses the impact of the American Reinvestment and Recovery Act so far, the fate of female and older workers in this down economy, and which sectors of the California economy are likely to bounce back.

Questions for Dr. Smith:

1. Has the American Recovery and Reinvestment Act been successful in stemming additional job losses?
2. Will California regain its place as a leading global economy?
3. What does the future hold for industries such as manufacturing, construction, and retail that have been hard hit by this recession?
4. In some industries, such as government and aerospace, we are seeing older workers retiring in greater numbers. Is this good for the unemployment situation? Is “brain drain” a concern?
5. What are the best job prospects for older workers?
6. As the number of male and female workers reach equity, what are the implications for the U.S. workforce?

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Davide Accomazzo, MBA

The telegraphed day of reckoning has finally arrived and many commodity exchange-traded funds (ETFs) and exchange-traded notes (ETNs) are now finding themselves in the regulatory line of fire.

I have been on the record with my MBA students and with many of my colleagues in the investment business for quite some time regarding the multitude of problems associated with commodity ETFs. Finally, it seems corrective actions are being taken.

Just recently, UNG, the ETF that attempts to track natural gas futures’ performance, was subject to massive price distortions. UNG built a premium into its price versus its net asset value (NAV) of as much as 20% due to large inflows of money, which, ultimately, reflected investors’ bottom fishing. UNG was suddenly unable to expand its position due to an abrupt fear of breaching position limits in the futures pit.

The lesson learned? When an ETF cannot deliver on its strategy because of regulatory fear, the model is pretty much broken.

Deutsche Bank is closing down its leverage long oil ETF due to similar concerns, and its agricultural commodity ETF was stripped of its exemption on speculative limits in the correspondent futures markets. It will also find it more arduous to continue with the same business model.

Since their inception, I have been a great advocate of ETFs in general, but commodity ETFs in particular have always been ridden with issues. From a regulatory point of view, these are hybrid products backed by derivatives but traded like securities, which allows them to escape scrutiny. By using futures to manufacture tracking performance for the equity investor, they are also inherently leveraged while bypassing the leverage restrictions normally applied to equity products (this is an issue not only with commodity-related products but with index ETFs as well).

Practically speaking, commodity ETFs were built on the (wrong) assumption that prices will constantly rise over the long term (i.e. long only products or funds that only invest from the long side) with obvious price distortion ramifications in markets like commodities that are built for hedging purposes. Commodities have really no beta because they are consumable, transformable, and perishable assets (in brief terms, beta is the passive return or risk premium associated with a specific asset class—frankly, I am beginning to think that the concept of beta is one massively flawed idea in every market, but that is material for another post). The idea that equity investors should passively include this asset class in their portfolios was another of Wall Street’s brilliant, self-serving ideas driven by the never-ending search for a way to repackage risk and earn fees. If an equity investor feels the need to incorporate inflation hedging in his or her portfolio, or seeks an edge in overweighting the commodity sector, there are already plenty of viable choices, such as Treasury Inflation Protected Securities (TIPS), commodity stocks, and gold.

Commodity trading is just that—trading, exploitation of anomalies, and price arbitrage. It should always be approached in that way and not as passive allocation. Futures traders, commodity trading advisors (CTAs) and hedgers are the natural players in this game. ETFs? Not so much.

From a strategic perspective, it is reasonable to expect a potential dull period in commodities for quite some time as these ETFs are forced to close or downsize.

Welcome to a new “normal” in commodities?

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Wayne Strom, PhD

Today’s harsh economic realities continue to impact everyone. Hundreds of thousands have been losing their jobs each month. In California, even firemen and policemen are being laid off (California firemen are being laid off even as we approach fire season!). It does not matter if you work for a private enterprise or a tax-supported agency.

Everyone is somewhat at risk. Everything is somewhat on the line.

An attorney friend once told me, ‘When you have a fire, you get to choose: you can pour on water, or you can pour on gasoline.’ This is absolutely true in our business relationships.

When people feel at risk, they become anxious and can easily rise to defensiveness. Negotiations, even over the smallest issues, can become brittle.

But to pour on gasoline does not mean that one is operating from a position of strength and confidence! It does not signal the other person that you are competent to deal with what is happening. If I anxiously enter a business conversation, or if I am even just a little apprehensive (a form of defensiveness), or perhaps a little pushy, I may be setting the stage for a defensive push-back or confrontation.

We all give off and receive very subtle emotional signals.

Sometimes, we receive them below the level of conscious awareness. The impact of such subliminal perception is real and we can temporarily lose control of our reactions. If we receive subtle indications that another person is anxious or is being defensive, our brains interpret that something is not right. The result is that we become more guarded and less open to calm and direct communication. The suspicious aspects of our minds, which we usually hold in abeyance, silently and swiftly arise. And if that happens, gasoline has been added to the fire!

On the other hand, if I have sufficiently prepared myself—not just the paperwork, but in all aspects of psycho-physiology—the result can be very different. If I walk into a meeting in a calm and quietly confident manner, I may be lowering the other person’s need for self-protection. I may actually give him temporary relief of his own anxiety and make him more open to doing business with me. Just because I am not reacting out of my own anxiety and defensiveness! This is how the trust and rapport needed for business is established.

It is usually true that when we react out of defensiveness or anxiety, we are operating out of weakness, not strength. Men and women who face difficult issues from a position of strength do not have to raise their voices or react defensively.

Truly strong business professionals remain calm—and their calm confidence and strength is what helps win over those on the other side of the negotiating table.

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Can’t see the video above? Click here to watch or read the transcript.

In this video interview, Davide Accomazzo, MBA, Adjunct Professor of Finance at the Graziadio School of Business and Management, discusses the dangers of high frequency trading. This interview is a follow-up to Professor Accomazzo’s essay for the GBR blog on the same topic.

Professor Accomazzo teaches global capital markets and investments/portfolio management and is a frequent writer on the topic of markets and other economic issues. He co-founded Cervino Capital Management in 2005 and is the company’s principal trader.

Questions for Professor Accomazzo:

1. What is high frequency trading?
2. Why is it a growing problem and who stands to lose?
3. What is the worst possible scenario if HFT goes unchecked into the future?
4. What kinds of checks and balances do you think should be put in place?
5. Is there anything investors can do to mitigate the risks of HFT or is it out of our control?

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