Harvard College Investment Magazine February 2009

Investment Harvard College

Magazine Winter 2009

Rebuilding the

Global Economy

Trading Obama Corporate Goverance Industry and the ISS Decoupling and the Developing World Dubai: The Unexpected

HCIM

Table of Contents features

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06 10 13

Trading Obama Kylie Francis

Corporate Governance Industry and ISS Jonathan Greenstein

Decoupling and the Developing World Max Young

Dubai: The Unexpected Matthew Lee

Inside Scope

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The ETF Revolution Eugene Astrakan

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A Good Business: The Case for Open Source Software Samantha Fang

23 25

An Interview with Steven Berkenfeld of Barclays Christian Franco

An Interview with ShoreBank Sarah Wang

Inside the Profession

27 29

An Interview with Evie Dykema, Founder and Principal of NAVSTAR Advisors Yiying Xu An Interview with Martin Roll Rika Christanto, Former Editor-inChief

Investing Today

31 WINTER 2009

How to Be “One Up on Wall Street” Kamoy Smalling

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Investment Harvard College

Winter 2009

The Harvard College Investment Magazine (HCIM) is a semi-annual publication devoted to presenting the significant and current topics of investment and finance. Blending professional articles, interviews, and academic research, the magazine offers a comprehensive array of commentary to the investment field, serving as a platform of intellectual exchange between the professionals and the Harvard academic community.

Magazine

www.harvardinvestmentmagazine.com Editors-in-Chief Senior Editors

Zachary Rosenthal Stanley Chiang Eugene Astrakan Samantha Fang Kylie Francis Jonathan Greenstein

Matthew Lee Sarah Wang Maxwell Young Chelsea Zhang

Editors

Christian Franco Kamoy Smalling

Yiying Xu

Phone: 617-792-8847 E-mail: mklee@fas.harvard.edu

Strategy Board Director

Sergali Adilbekov Kamoy Smalling

O N E-YEAR SUBS CRI PTI ON

Strategy Board Assistant Director & Director of Communications

ADVER TISING

Phone: 478-997-1596 E-mail: mklee@fas.harvard.edu

United States Canada International

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INSTITUTIONAL

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US $20 US $24 US $30

AR TICLE SUBMISSIONS Phone: 478-997-1596 E-mail: jgreenst@fas.harvard.edu

Strategy Board

Executive Designer

Erin McCormick

ASSISTANT DESIGNER

Moonlit Wang

EMERITUS ALUMNI BOARD

JOIN HCIM E-mail: jgreenst@fas.harvard.edu

Harvard College Investment Magazine Harvard University University Hall, First Floor Cambridge, MA 02138

Peter Boyce Polina Dekhtyar Xiang Du Matthew Fleck Elizabeth Fryman Dan Gong

fACULTY ADVISORS

Dilyana Karadzhova Matthew Lee Keith Martinez Nicole Rhodes Sarah Wang Yiying Xu

Kuanysh Y. Batyrbekov (Lehman Brothers) Rika Christanto (Morgan Stanley) Michael Hauschild (Citadel Investment Group) Biran Kozlowski (DC Energy) Jennifer Y. Lan (Merrill Lynch) Benjamin Yihung Lee (Bain and Co.) Anna Haisi Yu (Citadel Investment Group) John Y. Campbell Jeremy C. Stein

COPYRIGHT 2009 (ISSN: 1548-0038) HARVARD COLLEGE INVESTMENT MAGAZINE. No material appearing in this publication may be reproduced without written consent of the publisher. The opinions expressed in this magazine are those of the contributors and not necessarily shared by the editors. All editorial rights reserved.

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HCIM

Letter from the Editors Dear Readers,

W

elcome to another issue of the Harvard College Investment Magazine. We bring you a broad assessment of some of the most interesting trends in finance today.

2008 has been a trying time for our domestic and global economies, with Wall Street at the center of the subprime mortgage crisis and the ensuing global recession. As our nation prepared to elect its first African-American President, Lehman Brothers filed the largest bankruptcy in U.S. history. Now with Barclays absorbing Lehman and Bank of America acquiring Merrill Lynch, finance and its major players are changing fundamentally. For investors and job seekers alike, anxiety and uncertainty have replaced optimism and intuition.

The economic crisis has impacted HCIM as well, albeit on a much smaller scale. In our efforts to reach readers beyond the Harvard campus, we launched our website, www.harvardinvestmentmagazine.com, in August 2008. This past year we also introduced the Strategy Board to broaden our presence on campus. After a reduction in the number of firms able to advertise with us this year due to economic instability, we are happy to present you with our winter issue.

HCIM wishes to remind its readers that the business cycle is hopefully just that – a cycle. While the economy has unquestionably continued to decline in the past year, with patience and greater scrutiny, the market will gradually recover. A study of finance should not be limited to investment tips alone. Rather, we offer a glimpse into the effects of the market on a number of different sectors, from betting on U.S. politics to investing in Dubai and the developing world.

Our writers explore not only the fundamental problems of corporate governance that led to the crisis, but also specific growth sectors of the economy, such as the growing popularity of exchange-traded funds and open source software. Finally, our interviews provide pertinent advice toward securing a career in finance during this time of transition.

We would like to thank our staff for their dedication, hard work, and insight over the past year. We also owe our thanks to the members of our Emeritus Board, particularly Jennifer Lan, for their continued interest and support in the evolution of HCIM. As the bailout plan rebounds in Congress, even as the corporate structures of the banks change dramatically, Wall Street remains a center of intellectual inquiry and government expenditure. We hope that like HCIM, you will look to the current marketplace not simply as a burden but as a learning experience about the changing world economy and our place in it.

Regards, Zachary Rosenthal and Stanley Chiang Editors-in-Chief

Trading Obama

By Kylie Francis What’s better than watching your favored candidate win the election? Making a buck for it.

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n the Iowa Electronic Markets (IEM), investors trade a variety of “futures” whose pay-offs are linked to the outcomes of America’s elections. Academics at the University of Iowa set up the IEM in 1988 in order to help teach students about finance. The markets are not for

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futures in the classical sense – that is, promises to exchange some good or service at a fixed date and price.

Rather, they are of the “cash-settled” variety. Consider the IEM’s “winnertakes-all” market for the American presidency. People could bet on presidential candidate Barack Obama by buying a contract that paid a dollar if he won and nothing if he lost.

Anyone certain of an Obama victory should have been willing to pay up to a dollar for the contract. Anyone confident that Obama would lose could have sold such a contract, expecting to pay nothing when the result came. But these markets have greater implications than monetary gains and losses to individuals; they also serve as an accurate predictor of the actual outcome of an election.

During America’s recent presidential election, bets on the Iowa Electronic Market, and on online exchanges such as www.intrade.com, were watched almost as keenly as

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opinion polls. Here, the IEM voteshare markets were of particular interest because the trading price of futures contracts within these markets served as an estimate of the percentage popular vote likely to be garnered by a given candidate. The idea is that futures and options markets aggregate information about the anticipated future values of stocks and commodities and then reflect this information in their prices. As the “expectations hypothesis” asserts, futures prices are the best predictors of actual future spot prices.

In the IEM vote-share markets, traders initially invest between $5 and $500. The payoff of a futures contract equals the relative percentage of the popular vote received by a candidate multiplied by $1. So, contracts for a candidate who received 32.4% of the popular vote will be worth 32.4 cents each. Because real money is used, traders are subject to the monetary risks and returns that WINTER 2009

features result from their trading behavior.

Presumably, the more confident they are in their predictions, the more money they will be willing to risk.

In this way, prediction markets make use of traders to aggregate information from individuals, polls and other sources, weighting all of this through the price formation process. As prices of these instruments converge about some expected future value, it provides a forecast of the popular vote outcome.

Although polls are still a main source of forecasting elections, they have proven to be less accurate than prediction markets. In a recent review of the major approaches used in forecasting election outcomes as applied to the 2004 experience, Randall J. Jones, Professor of Political Science at the University of Central Oklahoma, found that in comparison with most methods of forecasting the popular vote, the IEM was the superior performer with a mean absolute error of 0.06% over the 34 weeks preceding election day versus a mean absolute error of 0.6% for polls.

The growing ineffectiveness of polling can be largely attributed to problems with Random Digit Di-

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aling (RDD). The availability of call screening technology and the prevalence of cellular-telephone-only users have made it increasingly difficult and expensive to contact certain groups of voters, to their exclusion.

Prediction markets are not subject to such pitfalls. First, instead of being a randomly selected representative sample, IEM traders are selfselected. And instead of weighing their opinions equally in the price formation process, the market price is a metric, which, through trading behavior and market dynamics, depends upon the traders’ forecasts and the levels of confidence they have in those forecasts. These are not based upon traders’ individual preferences but upon how they think everyone will vote in the actual election. In addition, each trader in the market is able to see the net effect of the beliefs of all other traders and the time series of changes in those beliefs, and he can alter his own perceptions accordingly. This makes the market more than a static one-time prediction; it is a dynamic system that can respond instantaneously to the arrival of new information.

Problems with polls also arise because often the environment

can change quickly. Political campaigns are designed to influence how people will vote in an upcoming election. They often react to counter poll results and, if they are effective, essentially invalidate the poll predictions. This is not the case with prediction markets, which pose several challenges for campaigns that might want to influence them. First, the campaign would have to be able to affect market prices. Attempts to manipulate prices create profit opportunities for other traders, and the exploitation of these opportunities makes manipulation efforts difficult to sustain given account limits. As a result, each trader is small relative to the market as a whole. Moreover, beyond believing that it can influence prices, the campaign would also have to believe that voters change their votes in response to market prices and do so in a predictable way.

As yet, there is no evidence that voters respond to market prices, and the direction of any potential response is certainly debatable.

So how confident are you that President Barack Obama will be reelected in 2012? Prediction markets allow you to put your money where your mouth is.

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The Proble Governan

By Jonathan Greenstein

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The Institutional Shareholder Service’s opinions affect the governance decisions of institutional investors controlling around $25 trillion in assets, roughly half the world’s common stock.

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ollowing the turn-of-the millennium financial scandals, academic attention has focused on the role of shareholder activism and government regulation in demanding corporate accountability. By contrast, and especially in the wake of the current financial crisis, the role of the corporate governance industry as an extremely influential voluntary regulator has comparatively been ignored.

This industry, which includes governance consultants, governance ratings firms, and proxy advisers, influences or controls the corporate proxy votes of trillions of dollars of equity. As the industry’s corporate ratings and recommendations impact governance policies and investor decisions, the industry effectively serves as a very powerful for-profit corporate regulator.

Beyond the question then of how this industry has attained such an influence, a closer examination of the way in which its influence is manifested raises potentially serious problems with the industry generally, and with its unquestioned leader, Institutional Shareholder Service (ISS), specifically. The major problem is the potential conflicts of interest similar to those that have been raised in connection with other types of ratings agencies and auditing firms.

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ematic Corporate nce Industry There are also the more theoretical problems regarding the inconclusive evidence on the causal relation between governance and performance, and of the drawbacks to cookiecutter governance that the industry threatens to implement. Ultimately, then, despite the potential benefits that the industry can provide, there is a need for far greater oversight of the industry itself.

An Overview of the Corporate Governance Industry and ISS Where Supply Meets Demand: Explanations for Growth The demand for the corporate governance industry emerged as a result of increased regulations for institutional investors. In 1988, the Department of Labor stated that “the fiduciary obligations of prudence and loyalty to [pension] plan participants and beneficiaries require the responsible fiduciary to vote proxies on issues that may affect the value of the plan’s investment.” Following this, managers of employee retirement plans started looking for help in executing these fiduciary duties. In 2003, in response to the financial scandals and governance breakdowns at the likes of WorldWINTER 2009

Com and Enron, the SEC mandated that investment advisers have a fiduciary duty to vote proxies “in the best interest of clients” and that mutual funds have to disclose not only their proxy voting policies, but also how they actually voted. Looking slightly ahead, although it has been tabled for the 2008 proxy season, an NYSE proposal to eliminate broker discretionary voting in director elections would result in a further shift of voting power from brokers to institutions, and, therefore, to proxy advisory services.

The other major force enhancing market demand has been the increasing influence of institutional investors that presents a very lucrative market for governance advisers.

Because investors often do not have the time or resources to devote to a complex analysis of a company’s governance structures, it is advantageous for them to outsource their governance research. According to ISS, over 28,000 corporations send out proxy statements that contain around a quarter of a million separate issues to be voted on. More important, though, than the purely economic considerations are the legal protections that hiring governance experts can provide for these institutional investors for their proxy voting decisions.

Key Players and Industry Practices The corporate governance industry has taken advantage of these increased regulatory requirements, highly visible corporate scandals, increased shareholder activism, and corporate managers’ and directors’ increasing interest in shareholder concerns by providing the market with general corporate governance advise, proxy advice, and governance ratings. Founded in 1985 by Robert Monks, ISS is the “800-pound gorilla” in the proxy advisory business.

In 2007, ISS provided nearly 3000 global clients with proxy research and voting services to help them with their proxy voting responsibilities. These proxy advisory services involve ISS’s reviewing shareholder and company proposals and either offering advice on how the matter should be voted or in many cases clients directly voting on the behalf of their clients.

ISS’s other principle source of influence is its corporate governance ratings system. The ratings are based on approximately 60 criteria for US companies. These variables are structured so that they can be analyzed through yes/no/not disclosed indicators, and are weighted in an attempt to align the rating variables

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features with objective performance measures. The ratings, though, are not only provided to institutional investors, but are also available to subject companies as part of ISS’s company advisory service.

ISS’s Influence While the RiskMetrics Group’s motto “The Center for the Financial Community” is intentionally selfserving, analyzing ISS’s reported numbers and its role in actual proxy contests does lend some credence to its claim. ISS’s opinions affect the governance decisions of institutional investors controlling around $25

Hathaway), 15-20 percent of ISS’s clients have also outsourced their actual proxy voting responsibilities.

As a quantitative measure of ISS’s increased value, in November 2006, just five years after changing hands for less than $40 million, ISS was sold to RiskMetrics for $553 million.

On top of these figures are the highly-publicized examples of ISS swaying corporate decisions. ISS’s coming-out party is widely considered to be its role in the fight between Hewlett-Packard’s (HP) management and some of its largest shareholders over HP’s proposed acquisition of Compaq in 2002. ISS’s

as knowledgeable is principle among these potential benefits. Additionally, the corporate governance industry, through the proxy voting process, is able to present a relatively cohesive front to management and the board of directors. By controlling as much of companies’ securities as it does, ISS, as the de facto voice of the institutional investor, has the capacity to solve the collective action problem of shareholder-led governance movements. However, there are several problematic areas with practices in the industry that need to be properly addressed before the benefits fully outweigh the costs.

ISS, as the de facto voice of the institutional investor, has the capacity to solve the collective action problem of shareholder-led governance movements. trillion in assets, roughly half the world’s common stock. ISS serves approximately 2,850 clients worldwide (around 1700 of which are investors). By its own count, ISS’s investor clients include 7 of the top 10 prime brokers, 59 of the top 100 hedge funds, 70 of the top 100 investment managers, 23 of the top 25 mutual fund complexes, and 17 of the top 25 public pension funds.

Not all of these 1700 clients rely on ISS’s services equally. As would be expected, the firms with fewer resources rely more heavily on ISS. Similarly, many firms that practice purely quantitative or index investing tend to vote more in line with ISS. While firms do at times override ISS’s decisions (as when ISS recommended against reappointing Warren Buffet to the board of Berkshire

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clients held 23 percent of outstanding shares (including 9 percent by index investors). After hearing HP’s CEO’s pitch, ISS recommended the merger, which won investor approval by less than 3 percent. With this kind of influence on institutional investors, ISS might be considered as a for-profit corporate regulator.

Problems with the Corporate Governance Industry and ISS There are many arguments to be made for the benefits of a separate corporate governance industry.

Allowing the option for corporate governance experts to vote on corporate governance issues instead of the institutional investors who do not have the time or resources to become

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Conflicts of Interest The main problem with ISS’s business models is that it advises both a company and a company’s shareholders, leading to the worry of an unfair ratings environment.

Furthermore, companies can retain governance rating firms for other services. Corporations could feel obligated to retain these services in order to obtain favorable recommendations. For example, an officer of Agilent Technologies reported that Agilent had paid ISS’s proxy service $20,000 for advice on a stock-option proposal. ISS’s consulting arm then asked for an additional $16,000 to help Agilent improve its score on governance issues. More conflict potentially exists from the fact that owners or executives of advisory WINTER 2009

features firms may have ownership interests in corporations that have proposals on which the firm is advising.

During the HP-Compaq merger proposal, ISS failed to disclose that it was partially owned by a firm that did extensive business with HP.

One-Size-Fits-All Governance Although ISS’s recommendations are not enforceable in the manner that governmental regulation is, because ISS does have such an influence, its recommendations may nevertheless produce conformity.

However, no one governance structure is right for every corporation.

Pressuring companies to adopt a homogenized set of governance rules may ultimately harm the competition for capital as these measures may be inappropriate for certain companies.

The measurements based on yes/no/ not-disclosed possibilities often fail to capture importance nuances in corporate governance policies.

As ISS is a for-profit company itself, there are practical explanations behind its cookie-cutter approach. For one, this more objective method may allay concerns about conflicts of interest. This approach also facilitates advising on as many proxies and as many companies as it does. It may also exist simply out of an inability to proceed otherwise. As was raised following ISS’s influence on the HP-Compaq merger, not only is the size of ISS’s staff relatively low for the influence they carry, but the quality of employees at ISS is too. As one hedge fund manager remarked after ISS’s analysis process, “[ISS] is like someone who goes to see Siegfried and Roy and says, ‘Wow, they really made an elephant disappear.’”

Having this very basic, straightforward method of governance ratings allows ISS to complete the amount of reviews in the assembly-line fashion necessary for it to stay on top of the industry.

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Unproven Metrics Another theoretical problem relates to the issue of whether the evidence matches up with the advice given by the corporate governance industry. Without much proof of a causal correlation between specific governance practices and performance, it is unclear why recommendations should be acted upon (except to enable an investor or company to say “we followed the experts”). In following the discussion on homogenized governance, there is the real risk that certain “best practices” may actually be detrimental to some firms. For example, while ISS’s record on board control recommendations and CEO pay have generally been good, ISS has routinely endorsed exorbitant mergers that have destroyed billions in shareholder value.

ISS’s Fiduciary Duty The majority of the problems mentioned above stem from the fact that the corporate governance industry is driven by profits. Firms continually update their services to not only remain competitive, but also because it is simply good business.

These problems become even clearer after ISS’s own recent IPO as a part of RiskMetrics in January 2008, as ISS now has a fiduciary duty to maximize shareholder value.

This push to stay on top and cater services to clients’ needs can adversely affect corporate governance practices because of the advisory firm’s influence. For example, in voting against Fifth Third’s CEO in 2006 because of poor stock performance, despite the company’s having better governance practices than 99.8 percent of the companies in the S&P 500, ISS claimed to be accommodating its clients focus on performance. However, in doing so, ISS created incentives for earnings manipulation, precisely the activ-

ity good governance should prevent.

Additionally, apart from their proxy advisory services and governance ratings, ISS also offers more specialized services on social issues, securities class action, M&A analysis, public fund advising, and Taft-Harley advising among others. All these services present further opportunities for conflict to arise between its basic best practice governance advisory and ratings and its desire to make money.

Conclusion At a time when corporate governance issues are important shareholder concerns, it is telling that governance analysis is being outsourced. These firms, however, are not fully accountable for their work and are primarily concerned with their own financial interests. This unaccountability is magnified by the fact that these firms have attained such an influence on how corporate decisions transpire.

That is why the unchecked power of the industry in its current state should be corrected. At a minimum, the SEC could outlaw blindly following firms and could clarify investors’ fiduciary duties with respect to proxy voting. Ultimately, as these issues relating to the corporate governance industry in many ways resemble those pertaining to auditing and consulting firms, it is important that the impact of treating governance as a business be fully evaluated.

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features

D

ecoupling eveloping and the

World

By Maxwell Young

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features

B

uzzwords come and go quickly in the investment world, but among the most pervasive and interesting to appear in the last year was the term decoupling. Decoupling holds that emerging economies have developed to the point that their newfound breadth and depth insulates them from an economic downturn in the United States. Even before the global financial crisis deepened in the summer and fall of 2008, however, decoupling had its share of critics – critics whose claims now seem to be validated. Although international financial markets held up well at first, as the focal point of the crisis moved from American housing to international credit markets, emerging economies began to suffer. But does this suffering, under the current circumstances, eliminate any validity the theory of decoupling may have had?

No one can deny that economies around the world have become more integrated over the past decades. Emerging economies’ exports have grown as a share of GDP, and they export not only to industrialized countries like the United States but to other developing nations. These trade increases come as a result of lower transport costs for both air and ocean shipping, as well as improved policy conditions; tariffs and other trade barriers have moderated. Another, less discussed area of integration pertinent to understanding the theory of decoupling was raised by Federal Reserve Vice Chairman Donald Kohn in a speech he delivered in June: financial integration. He points out that foreign equity holdings as a share of total equity portfolios have increased from 9 percent in 1997 to 19 percent in 2007. He postulates that, due to financial integration, financial channels are becoming instruments of channeling shocks between economies – in fact, financial transmission of shocks may now be more important than traditional trade transmissions.

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Increased integration, however, does not necessarily mean synchronization of business cycles across countries. Indeed, greater amounts of international trade would lead one to expect that demand shocks would have more deleterious effects across economies. In fact, economic theory does not necessarily predict this; as international trade promotes specialization, individual economies should be driven by developments specific to these specialized industries. Furthermore, just as improved policy conditions allow for more international trade, better monetary and fiscal policies have made emerging markets more flexible and lowered inflation.

One indication of this is that credit spreads between sovereign bonds of emerging economies and U.S. Treasuries have become less sensitive compared to early crises, such as the collapse of Long Term Capital Management.

When decoupling first became a popular investment term, the slowdown in the United States was driven primarily by the domestic housing market. A major change took place,

however, when the credit crisis began in the summer of 2008; the economic pressure shifted from being centered on the U.S. economy to being truly global in nature – credit terms and availability worsened worldwide. The international credit crisis would be the litmus test for decoupling. Just how would emerging markets hold up, and would some do better than others? If so, which? When asking such a question, there can be no better place for the international investor to look than the BRICs and N-11.

The term “BRICs” first appeared in a 2003 Goldman Sachs paper, and quickly became a byword of economists, investors, and the media. The BRIC countries are Brazil, Russia, India, and China; in 2007, they collectively accounted for 40 percent of global GDP growth, and are predicted to be among the world’s largest economies by 2050. With such impressive growth statistics and reservations as the world’s largest economies, before long the BRICs were a favorite of global investors. In late 2005, to considerably less fanfare, Goldman Sachs released a new paper on the Next

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features Eleven (or N-11) countries. The report named eleven nations that, based on macroeconomic stability, political institutional development, trade and investment openness, and education, are next in line (after the BRICs) to rank among the world’s largest economies. The members of the N-11 are Mexico, South Korea, Vietnam, Pakistan, Indonesia, Iran, Nigeria, Bangladesh, Egypt, Turkey, and the Philippines. Although the report on the N-11 said that only Mexico and South Korea had the potential to truly rival the BRICs, the remaining countries were nonetheless highly promising.

In the year after the initial report, investors excitedly bought into the BRIC economies; the Bovespa (Brazil’s benchmark index) gained 30 percent in the year after the original Goldman Sachs report was published, and the Bombay Stock Exchange’s SENSEX index 21 percent; the S&P 500 managed only an 8 percent gain within the same time period. Indeed, from 2003 until the beginning of the subprime crisis in the summer of 2007, the MSCI Emerging Markets Index, major components of which are stocks from the BRICs and N-11, gained 179 percent; t h e

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S&P grew 54 percent during the same period. The top performer over this period was Vietnam; the Ho Chi Minh Stock Index averaged more than a 160 percent annual gain from 2003 until July 2007! Over the same period of time, the best investment among the BRICs was Russia, although the RTS Index averaged a “paltry” 66 percent annual gain by comparison. And while Vietnam is the exception rather than the rule for N-11 performance over this period, several still manage to rival Russia: Egypt and Indonesia both managed 66 percent annual returns as well, and Mexico an impressive 77 percent.

Taking another step back, we can see that BRICs and the N-11 alike outperformed markets in developed nations; the S&P 500 and FTSE 100 had average annual returns of 12 percent and 13 percent, respectively. As the subprime crisis began, decoupling continued to look appealing; American markets began to give back their gains, while international stocks held up quite well. But as the condition of credit markets declined, so too would the performance of global security markets.

The impact of the credit crisis delivered a heavy blow to decoupling. Beginning in the summer of 2008, risk aver-

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sion rose around the world and global markets tumbled, following the trend begun in America. As of the first week of November, the MSCI Emerging Markets Index had declined some 54 percent in 2008; this compares to a 42 percent decline for the MSCI World Index, which consists of developed, not emerging, markets. Russian and South Korean markets have fallen particularly hard. Russia’s dollar-denominated RTS Index is down more than 65 percent in 2008, aided in part by the war with Georgia and the collapse of commodity prices - the RTS is heavily-laden with natural resource stocks. Taken as a whole, the BRICs are down over 30 percent for the year.

South Korean shares are down almost 60 percent for the year, and the won has hit historic lows against the dollar.

While the performance of emerging economies’ bourses up to the beginning of the credit crisis was enough to warrant decoupling real attention, their subsequent performance has put paid to any remaining belief that the theory holds in the current market.

Although it cannot be said that globalization has resulted in industrialized and emerging economies marching in lockstep, the current financial crisis has shown that the theory of decoupling - while not necessarily wrong in and of itself - cannot be lent credence today. This is not to say that the BRICs and N-11 should be scorned; indeed, the great promise of these economies remains. Emerging markets continue to display superior economic fundamentals, and many of their banks are untainted by the toxic assets that continue to plague their counterparts in industrialized countries.

While the current crisis may perhaps be a death knell for decoupling (at least for a time), the poor performance of the BRICs and N-11 only means that investors should examine them all the more intently.

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Dubai :

The Unexpected

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By Matthew Lee

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thousand miles southeast of Baghdad, one hundred miles from Iran, and right at the meeting of the Persian Gulf and the Arabian desert, one of the last things one might expect to find is a ski resort, the only seven-star hotel, and the world’s tallest building. Yet all of these and more are landmarks of the booming Dubai City in the United Arab Emirates, where the city itself, more than its various attractions, may be the most unexpected phenomenon of all.

A Curious Past In contrast to the fame and attention Dubai commands today, the city began humbly in 1833 as a settlement focused on fishing, pearl diving, and trade. By the 1950s it had emerged as a thriving port, which continues to be a large part of its economy today. But the

Dubai of just a few decades ago is hardly recognizable in the prodigious skyline—and coastline—that has emerged in recent years. The city’s growth was spurred by the 1966 discovery of oil in the emirate and the visionary decision by ruler Sheikh Rashid bin Saeed al Maktoum to use the oil revenues to develop Dubai.

The plan called for massive development of infrastructure, including schools, roads, and the airport. Business and tourism industries began to expand, facilitated by the policy of taxing neither personal nor corporate income and by the creation of the tax-free Jebel Ali Free Zone to facilitate Dubai’s position as the trade hub of the region.

Hope and Promise The catalyst of oil, visionary leadership from the ruling Maktoum family, and an optimal location at

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features the junction of Asia, Africa, and Europe has created something of a perfect storm for economic development. With so much growth in business and tourism, Dubai, unlike many of its neighbors, is no longer dependent on oil revenues. (Oil does, however, allow the government to operate without collecting any taxes.)

It is both shocking and promising that while Saudi Arabia next door relies on oil for 44 percent of its GDP, Dubai thrives with oil-related industry at less than six percent of its GDP. The transformation of Dubai to its present status as a world-class tourist destination is an incredible achievement. But despite the city’s prodigious growth to date, its development remains in the preliminary stages. Dubai is aiming for 15 million visitors in 2015 and 45 million in 2025, up from 6.5 million in 2006.

The number of tourists to the entire

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purchaser of the Airbus A380 (the 550 passenger “Superjumbo” Jet) after increasing its purchases in August 2007 to 55 percent of the aircraft.

The Dubai Airport, where Emirates Airlines is based, is already one of the top ten busiest airports and in 2007 was the fastest growing in the world.

But just what does Dubai expect will attract millions of future tourists?

Building the Future With nearly 25 percent of the world’s cranes in the city and a new building springing up seemingly everyday, much of the magic must be the huge development projects which have caught worldwide attention.

Already in operation is the aforementioned “seven star” Burj al Arab, the iconic sail-shaped hotel built on a manmade island connected to the city proper by a private bridge and a

Dubai thrives with oil related industry at less than 6% of its GDP.

Middle East was 35 million in 2004, a milestone year for the region which marked the first time more tourists visited the Middle East than the continent of Africa.

But with 1.5 billion people a mere two-hour flight from Dubai, the city’s ambitious goals just might be possible. The city certainly thinks so. Dubai has aggressive plans for Emirates Airlines, the state-owned airline, already the largest in the Middle East. The company made headlines last year as the biggest

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fleet of Rolls-Royces. Emaar Properties’ Mall of the Emirates, another icon of Dubai, features an indoor ski slope, built, no doubt, as an ironic and defiant contrast to the desert outside. Another project by Emaar is the Burj Dubai, which upon completion will be the world’s tallest building, substantially surpassing the current record holder Taipei 101.

The tower will feature the first Armani Hotel, in cooperation with the luxury designer Giorgio Armani.

But perhaps most incredible have

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been the feats of Dubai’s Nakheel company. Most famous for its land reclamation projects, the company is responsible for the Palm Islands— three massive manmade islands each in a stylized shape of a palm tree.

The first, Palm Jumeirah, is already habitable and alone doubled the coastline of the city. As the remaining two Palm Islands continue construction, Nakheel has moved to an even more ambitious project, the creation of “The World” archipelago just off the coast. This set of 300 manmade islands arranged in the shape of a map of the world has already largely been sold to invitation-only companies and investors for transformation into exclusive resorts, commercial centers, private villas, and other developments. Their projects together will add 600 miles of coastline to Dubai, to the tune of $60 billion.

In addition, Dubai has the vision to be more than just a tourist curiosity. The city has been attempting to make itself into a world-class financial center from scratch and has been busy erecting buildings and infrastructure in hopes of drawing in the business. It has invested heavily in various tax-free zones or “cities” within the city where different areas of business may find themselves at home. For example, Dubai’s Internet City already boasts the likes of Microsoft, Cisco, and Intel. The Media City is just down the road, and the Knowledge Village is on the way with the goal of making Dubai a destination for, of all things, education.

More than Glass and Steel But while the catalyst of oil and visionary leadership have played big roles in jump-starting this development miracle against the most awesome of odds, the sustainability of Dubai’s ambitious future will rely on more than money and the will to WINTER 2009

features spend it. Perhaps more important is something even harder to construct: a healthy social system. On this front, Dubai also excels, at least relative to many of its Middle East neighbors, in this region tainted by religious extremism and political volatility.

try has long been one of the most moderate in terms of foreign policy.

On the streets, while Emirati men and women wear traditional national dress—kandooras and abayas respectively—tourists and expatriates freely dress in western fare and can even consume alcohol and pork

A shocking 80% of Dubai’s 1.5 million population are expatriates...

Dubai is arguably one of the most westernized places in the Middle East, and the UAE as a coun-

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in many venues. In fact, in January 2008 President Bush gave a speech in Abu Dhabi, capital of the UAE,

praising the country as “a model Muslim state.” No less important than tax incentives and infrastructure—and perhaps more crucial— the moderate domestic and foreign policies of Dubai have allowed the city to prosper and will likely prove to be the critical advantage for the city as it continues to carve itself as the “model” for the region.

Cracks in the Sand Yet its rapid development is not without controversy. While Saudi Arabia and other Middle Eastern countries may precariously survive by churning oil into money, Dubai’s growth and dependent is precariously dependent as well: on expatriates and cheap labor.

A shocking 80 percent of Dubai’s 1.5 million population are expatriates, many of whom are poor South Asian migrant construction

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tis in their own country’s workforce.

The official prediction is that by 2020 less than four percent of the workforce will actually be Emirati citizens. A study at Sharjah University found that currently 33 percent of Emirati men and 48 percent of Emirati women are unemployed, numbers that would normally suggest severe economic problems but are less surprising considering the prodigious wealth the citizens are given just by being Emirati.

But the greatest worry for Dubai is whether the rapid growth will endure or instead could one day come crashing down. The Middle East region is currently fueled by a tremendous amount of capital, thanks to oil prices. The city-state has benefited from strong leadership from the top, especially from the highly venerated ruler of Dubai, Sheikh Mohammad. Yet the miraculous emergence seemingly overnight of this jewel in the desert, the appearance of palmand world-shaped islands off the coast, and the endless construction at an unprecedented pace has already raised eyebrows. The masterminds of Dubai have shown that they can

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build it; what remains to be seen is “will they come.”

In the Limelight of the World In the past several decades, Dubai has harnessed a fortuitous discovery of oil to fuel the rapid rise of this world-class city from a small corner of desert. It has built towers of glass and steel and molded islands from its own coast. In the process it has made Emiratis a minority in their own country and constructed extravagant wonders on the backs of migrant workers. In just a few short years Dubai has proven itself to be the master of the unexpected. Now the world expects the unexpected from this miracle city, and we are left wondering whether it can deliver.

But as the city’s skyscrapers keep growing taller and villas keep springing up on the fronds of its artificial islands, one thing is for sure—the world will be watching every step of the way.

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workers literally building Dubai’s future. The wage for these construction workers is a mere 550 Dirhams or approximately $150 a month. Indeed, a strike by construction workers in fall 2007 had sought an increase in wages to 700 Dirhams—all of $205 a month. The $55 difference is less than the cost of breakfast at the Burj al Arab.

Perhaps more surprising than these diminutive wages in a city famous for its extravagant wealth is that the labor protest occurred at all: unions and strikes are illegal in Dubai. The Human Rights Watch NGO has already raised concerns about the working and living conditions of migrant workers. Rumors abound about the poor treatment of the workers, though outright criticism is rarely seen. One reason may be the implicit censorship of the media against criticism of the ruling Maktoum family. Legal or not, strikes and other manifestations of the tensions in Dubai’s demographics are likely to peek above the sand again sooner or later.

Meanwhile, problems extend beyond just construction workers.

Having expatriates as such an enormous proportion of the workforce puts Dubai uniquely at risk of a very rapid exodus of talent should economic conditions for whatever reason become less favorable in the future. Recognizing the problem, efforts have been made to source more talent from the local Emirati citizenry, and indeed, Emiratis receive free education through university level.

Yet unfortunately for this goal, UAE citizens are given not only free education but free healthcare and free housing. All male citizens are entitled to a free allotment of land.

Even weddings are subsidized, with a nearly $20,000 handout. These benefits are playing out in textbook fashion as economic distortions disincentivizing participation by Emira-

Photographs by Matthew Lee

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inside scope

The ETF

Revo ution

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By Eugene Astrakan

here is a mountain of written and spoken public criticism targeting Wall Street and its wizardly ways. However, the average American would likely be pressed to describe how or even what tricks are being pulled. Yet it is puzzling that there has been so little outcry over the suffering of the average citizen at the hands of the mutual fund industry. This rip-off is quite real, and there are no tricks about it.

Fortunately, a viable force has emerged to help the retail investor and rattle the managed fund industry – the ETF.

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inside scope Mutual M isery In theory, mutual funds do small investors a big favor by allowing them to reduce risk by aggregating individually meager savings into pools large enough to diversify investments across many securities— all for a minimal management fee.

In reality, retail investors who funnel their money into mutual funds have likely been overpaying for underperformance. Mutual fund clients have historically faced very narrow investment options mostly limited to U.S. equities. Once launched, the funds have then annually underperformed their relevant index benchmark 80 percent of the time.

Most mutual funds are also saddled with a 1.0-1.5 percent management fee that eats into precious returns along with so-called “12b-1 service fees”—essentially marketing fees as high as 0.5 percent that subsidize printing and mailing of glossy fund advertising pamphlets to draw new investors. Furthermore, most

Americans are essentially bound to invest in mutual funds as they are the sole investment option of retirement plans such as the employersponsored 401(k). The introduction of the low-cost index mutual fund

by Vanguard pioneer John Bogle was a momentous step to right these problems. His innovation once shook the managed fund industry, and the exchange traded fund revolution may change it altogether.

Enter the ETF An exchange traded fund (ETF) is structured like a mutual fund but behaves like a stock. It tracks a broad array of securities such as the S&P 500 index and can be bought and sold inter-day like any other share through a discount broker.

Where mutual funds go wrong, ETFs do not. From the beginning, the ETF landscape has been dominated by indexes. The Dow Diamonds ETF tracks the blue chip average, the PowerShares QQQ

ETF tracks the NASDAQ index, and hundreds of other ETFs align themselves with indices of nearly every market and asset class. When investing money in unmanaged index-tracking ETFs, a retail investor does not have to worry about whether his fund manager is getting a good night’s sleep. By holding an index, the investor can lock in beta and rest assured that his or her money will not wind up in the ignominious 80 percent of managed mutual funds expected to underperform the market in any given year.

For these safe and superior returns, ETFs command razor thin management fees. By eschewing the acumen of expert managers, the funds are essentially left to be run by a computer. It copies any changes in index composition such as the replacement of one component with another and otherwise idles along.

ETFs also do away with mutual funds’ front and back end loads.

These are additional fees, usually set

The investment options at mom and pop’s disposal had previously been limited to a sampling of U.S. stock mutual funds.

Now, ETFs have essentially blow n open the doors to the entire investment universe.

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inside scope at 5 percent, that charge investors for buying into or out of a fund. Load details are buried deep within fund prospectuses which investors are unlikely to have opened in the first place. So, workers remain blithely unaware as a fraction of their hardearned income is siphoned off every month when they make a contribution to their 401(k) mutual fund.

ETFs, on the other hand, do not directly penalize investors for buying and selling shares of the fund..

From Grain to G old As retail investors’ collective hunger for ETFs grew and a multitude of new funds came on line since 2006, the asset management industry unwittingly underwent a rapid leveling of the playing field. The investment options at mom and pop’s disposal had previously been limited to a sampling of U.S. stock mutual funds. Now, ETFs have essentially blown open the doors to the entire investment universe. With the advantages of low cost and ease of purchase, indexed ETFs now exist for a huge range of sectors, asset classes, and investment strategies. For instance, the iShares MSCI BRIC Index Fund, which tracks a mixed index of Brazilian, Russian, Indian, and Chinese stocks, benefits those who are dissatisfied with the market malaise here at home and want to allocate a chunk of their portfolios to emerging market equities. Those who suspect that high energy prices are likely to fuel Russia’s energy-oriented businesses and want to target Russia more directly can purchase the Market Vectors-Russia ETF. The energy boom presents a strategic opportunity to capitalize on growing oil and gas prices. All it takes to enter the commodities market now is the purchase, for example, of the PowerShares DB Energy Fund ETF. Further still, if one concludes

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that the bull market in oil and gas will lift the currencies of commodity exporters like Australia and Canada, one can bet on their appreciation through the Elements Australian Dollar ETF and the CurrencyShares Canadian Dollar Trust ETF. In an erstwhile investment world, emerging market equities, commodities and currencies were asset classes reserved for institutional investors and ultra-wealthy individuals with direct lines to broker-dealers. No longer.

The tectonic plates of the world economy have shifted and, armed with the opportunities presented by ETFs, retail investors can now keep up.

If You Can’t B eat Them…

Assets held by ETFs are growing at an annual clip of 40 percent and now total over $600 billion.

ETF innovators such as State Street Global Advisors, Invesco, and Barclays Global Investors – parents of the SPDR, PowerShares and iShares series respectively – now face stiff competition from new players. These include giant investment managers such as Vanguard and Fidelity, firms widely known as trademark mutual fund families that have made adjustments to demand. Finally free of the old mutual fund binds, retail investors must now blow the dust off their portfolios and do the same.

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A Good Business:

The Case for Open Source Software

By Samantha Fang

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business strategy based on giving away products for free seems counterintuitive; after all, the incentive for creating a new product is the expectation of future profit.

In light of this principle, it seems difficult to explain the rise of open source software, where source code is made available to the public to be redistributed free of charge. But the growing popularity of open source software among technology startups, added to the success of established companies with open source foundations, indicates that entrepreneurs and venture capitalists see the initiative as an opportunity for profit.

An illustrative example: the website Sourceforge.net, which acts as a centralized source code repository for software developers, has hosted 169,281 projects with over 1,789,014 registered users since its launch in 1999.

The open source initiative is based on a set of principles that guide the availability of software, stating that source code should be openly available and a virtual community of software developers has the right to distribute and modify it.

While the word “free” has been associated with the movement, its main philosophy is that of “freedom” of expression, ideas, and information—

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while open source software is notably “free” of charge, its initial developers retain the license for its product. The promise of open source software lies in the collaborative, public manner of its creation—users can use, change, and improve software once it is released with an open source license; the redistribution of an initial software in modified or unmodified form allows for an unrestricted flow of information that harnesses the collective synergies of an entire network of computer programmers, software designers, consumers, and managers. And entrepreneurs have realized that potential—it seems after all that open source can be a good way to do business, and its collaborative philosophy can very well change the way we think about the power of information.

Harnessing Synergies The debate about the benefits of open source software centers on its opposition to closed source, or commercial proprietary software.

A movement built to increase the flow of software collaboration, open source eschews generating profit through traditional methods, namely the sale of individual software copies and patent royalty payments. Closed source advocates have claimed WINTER 2009

inside scope that open source software erodes the foundation of the commercial software market, as it generates similar products that are available for gratuitous use, but their claims have proved far from convincing. The commercial software business has proven extremely lucrative despite the launch of open source almost two decades ago, while open source software has served as the launch pad for innovative business strategies for profit. Far from destroying commercial software, open source software provides a means to gauge consumer preferences, introduce new concepts, and motivate commercial software companies—through healthy competition that drives the market—to innovate and invent the next “cutting edge” of technology. As a result, nascent technology startups have turned to open source to enter a highly competitive market, with the hope the first step can solidify into a strong foothold in the future.

David Wood, an entrepreneur at the University of Maryland, has written extensively on business incentives to use what he terms the “Open Source Software strategy.” To

core software under an open source license to great benefit. First, the unrestricted distribution of code creates opportunities for greater public awareness of a company’s existence, lowering the overhead expenses of advertising. The company can capitalize on the conferences organized by open source initiatives to perform stealth marketing, gauging public interest in the product while educating and introducing a new generation of users to its nascent business. At the same time, releasing technology under an open source license also generates a large set of testers, who through continuous use spot errors and reprogram portions of the code that contain bugs. The nature of an open source project necessitates that code is constantly flexible, evolving to user needs and consumer tastes.

In a fluid market of ideas and products, open source allows a product to be based on evolving academic research—academics frequently contribute to open source implementation—and cutting-edge ideas, ensuring the quality and the value of a new product. Open source harnesses the power of distributed peer review

important to the social welfare, these products signal the democratization of information, open to study and modification by anyone who has the capacity and the desire to do so.

Making a Profit Despite the benefits of free software distribution, open source projects remain difficult and costly to support. Attention inevitably returns to the bottom line that sustains the existence of the firm, and software startups have proved ingenious in their strategy to turn free software into substantive revenue. For one, a company often offers complementary commercial-quality installers, documentation, training, and support with its open source code, so while the source code is free, there is “gold,” as the BBC so ardently states, in software support, training, and publishing. Damian Conway, founder of the programmer-training business Thoughtstream, provides perhaps the most apt summary of the profit mechanism: “The most successful [means of profit] is definitely licensing support . . . That way people

In a fluid market of ideas and products, open source allows a product to be based on evolving academic research and cuttingedge ideas. cash-strapped startups, open source paves the way for cost reduction, free marketing, public awareness, and code stability. In fact, it has become routine for startups to release their WINTER 2009

and development transparency; as a result, it opens up the possibility of products that have better quality, higher reliability, lower cost, and more flexibility. And perhaps most

are getting something that they can work with free if they want to, but when they get into trouble they have backup and you make some money out of it.”

The success of Red Hat, Inc. has

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inside scope shown the extent of profit derived from the market for open source software, and the company serves as a model for startups interested in open source strategy. Founded in 1995, Red Hat currently has a market capitalization of $4.02 billion and employs over 2000 employees.

Matthew Asay of Infoworld argues that Red Hat’s business model, which deals with open source enterprises, with its emphasis on Red Hat Enterprise Linux (RHEL), was a “product of necessity”: lacking code ownership, it turned its weakness into a strength, creating a system from which it most effectively benefits. From a combination of free source code and commercial products, Red Hat transformed what was free software into a thriving business. Its strategy in driving Linux development has ensured the momentum and competitiveness of the open source project. At the same time, it provides the raw source of RHEL while selling the certified, compiled binaries of the product: large businesses, the main customers of Red Hat, often pay large sums for the certified RHEL, choosing to forgo the expenses of unsupported selfcompilation. In addition to its free product, Red Hat simultaneously includes a subscription package to its services, coupled with updates, which completes the user experience and simplifies use of its product. Therefore, while it is certainly possible for the public to use Red Hat’s products for free, the corporate consumers who make up the bulk of Red Hat’s revenue are more than willing to pay for the entire Red Hat Enterprise Linux experience. Red Hat’s experience electrified the software industry, opening up new possibilities for the use of open source software as a core business strategy.

Moving beyond the startup strategy, Marco Iansiti of Harvard

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Business School and Gregory Richards of Keystone Strategy found in their 2006 study, “The Business of Free Software,” that large information technology vendors also have substantive economic motivation to invest in open source projects. Such vendors include IBM, which has contributed more than $1 billion to the development and promotion of the Linux operating system, and Sun Microsystems, which has launched its own open source MySQL database and made its Java programming environment available for free download. Iansiti and Richard’s research found that managers and developers joined the open source community to learn and share new knowledge and skills, to “fill an unfilled market,” and to increase profit through supplying open source software-related services. Additionally, vendors invested

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heavily in open source projects related to their core, proprietary businesses. The creation of an open source community of developers and users allows the company to exert influence that will ultimately result in the use of its commercial product, and therefore increase revenue. The open source model can be considered a business tool that changes the dynamic of the commercial industry, allowing companies—from large corporations such as IBM and Sun to just-beginning enterprises—to reap from their efforts by pairing complementary products and services to free software programs. This fact ensures the continued existence, or rather success, of open source, as it is sustained by profit-oriented businesses which see immense potential in the business for free software.

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An Interview with

ShoreBank

By Sarah Wang

With Chairman and Co-Founder, Ron Grzywinski; Executive Vice President of Consumer and Community Banking, Jean Pogge; and Manager of Triple Bottom Line Innovations, Joel Freehling

S

horeBank is not your typical financial institution. As the nation’s first and leading community development and environmental bank, ShoreBank pioneered the popular concept of socially responsible investing and environmental lending. Founded in 1973 to help combat redlining within Chicago’s South and West Side neighborhoods, ShoreBank pursues a triple bottom line mission. Devoted to revitalizing and building strong, sustainable communities, ShoreBank understands that long-term community prosperity is closely linked to a healthy environment, so

HCIM: Social responsibility has always been at the core of ShoreBank’s mission. How do you think it will play into other financial institutions and corporations today?

Ron: Socially responsible investment and corporate responsibility are rapidly growing developments in America. I believe more than ever that great progress is possible only if we continue to blur the lines between social responsibility and entrepreneurship. Consumers are growing more media-savvy and sophisticated by the day. Just proclaiming yourself a responsible corporate citizen doesn’t necessarily WINTER 2009

environmental impact and profitability are parts of their mission as well.

Recently, HCIM conducted an interview with a few ShoreBank executives who have been instrumental in the design and implementation of the company’s innovative financial services and continued success, including Ron Grzywinski, Chairman and CoFounder of ShoreBank; Jean Pogge, Executive Vice-President of Consumer and Community Banking; and Joel Freehling, Manager of Triple Bottom Line Innovations.

make you one. You’ve got to prove it.

More and more in these post-Enron days, people are beginning to demand concrete action and measurable results when it comes to social responsibility—a trend that has helped drive more companies to embrace triple bottom line reporting. Not that long ago, it was enough to return an appropriate profit or boost our share price to an acceptable level. Increasingly, business leaders in the 21st century are being challenged not just to operate a successful business, but also do so in a socially aware and responsible manner.

HCIM: How has ShoreBank generally fared in the recent homeowner crisis and credit crunch?

Jean: Many financial institutions right now are taking losses and cutting back. At ShoreBank, one of our goals is to continue growing our mortgage lending business and double its portfolio to $300 million over the next twelve months. The difference in our response stems from our experience and history with single family mortgages. While we do make subprime loans, charging borrowers with fair credit scores just slightly more than the prime

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inside scope

“

I believe more than ever that great progress is possible only if we continue to blur the lines between social responsibility and entrepreneurship.

rate, our fixed-rate, escrow-included mortgages help our customers ensure sustainable homeownership and that we operate profitably. Our thorough income verification and personal service that includes holding onto the loan and servicing it once it has closed has met with astounding success: our portfolio and performance consistently meets or exceeds the performance of other comparable-sized more commercial banks.

HCIM: What role has ShoreBank taken in the growing industry of conservation lending and green banking?

Joel: ShoreBank created the nation’s first environmental bank in 1997, nearly a decade be-

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fore there was a second environmental bank in the U.S. Now green banks are proliferating at a rapid pace. However, despite the buzz surrounding green building in the construction industry, our focus on bringing these ideas and practices to low-wealth communities and to projects involving adaptive reuse is what makes us different. We’re committed to finding ways to bring green building practices to smaller projects, such as existing homes and places where the green building sector hasn’t yet made a huge impact. For example, there’s a desperate need for energy efficiency in Chicago, Detroit, and Cleveland homes. Our goal is to fulfill this need and in turn help bring more predictable and lower costs of energy to residents of lowto-moderate-wealth communities.

One program we have to address this is the Homeowners Energy Conservation Loan Program. In this program, we encourage and promote customers to consider energy efficiency when a customer inquires about a rehab loan for their home. We arrange, at no expense to the customer, an energy rater to inspect the home and the rehab plan to make specific rec-

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ommendations about ways to reduce energy costs and consumption in the home. In addition, our energy raters also share with the customer the costs and savings that are likely to accrue – in most instances, the upfront costs can be recouped in three to five years. If the customer completes more than $2000 of energy repairs, ShoreBank gives them a free Energy Star refrigerator.

HCIM: Do you have any advice or insight for Harvard students who are interested in getting involved in socially responsible investment or social entrepreneurship?

Joel: The green building industry is an incredibly exciting field. We see how fast it is growing in the number of new institutions that have environmental affairs departments and who are making significant investments, internally and in personnel. There is definitely a need for more interaction between the design community and the finance community.

Jean: My first career dealt with insurance and management. My second career was in the nonprofit world as the Executive Director of the Woodstock Institute. These two careers really came together when I arrived at ShoreBank. I love business, but I’m a mission-driven person. When I wake up in the morning, how much money I’m going to make is not the first thing I’m concerned with. I want to “do-good and do well,” and ShoreBank’s triple bottom line that values profitability, people, and planet really allows me to do that. That’s why I work here. The combination of business and mission is very exciting. It’s not easy to do both, but there are more and more young and mid-career people who are attracted to this business, and as a result, more and more businesses are becoming triple bottom line businesses. Get involved now. The role of business in the future will be different from in the past. The amount of dollars in socially responsible investments (SRI) continues to mushroom. There is a growing need for concerned business leaders who will create the world that we want to live in. Money is such a powerful force in the world today—when you link that with values, it will change the world in a very positive way.

I encourage everyone to think about a career in socially responsible investment.

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inside scope

An Interview with

Steven Berkenfeld of Barclays Capital

By Christian Franco

P

atience is the key to success, according to Steven Berkenfeld. In a recent interview with HCIM, Berkenfeld, a managing director at Lehman Brothers and now Barclays Capital, spoke candidly about the obstacles and challenges young people currently face when making career decisions. He advises

that students understand the expectations of their jobs rather than accept offers due to a misperception of advancement.

Such a philosophy has been the cornerstone of Mr. Berkenfeld’s long and successful career. Graduating from Cornell University in 1981, Mr. Berkenfeld continued his studies at the Columbia University School of Law. Afterward he worked at the law firm of Fried, Frank, Harris, Shriver, and Jacobson, where he realized his true passion for negotiating and carrying out deals.

In 1987 Mr. Berkenfeld joined Lehman Brothers and initially worked on investment banking and principal transactions. By 2001 he was entrusted with the responsibility of approving all transactions involving the firm.

At Lehman and now Barclays, Mr. Berkenfeld emerged as a business leader fulfilling three challenging positions that have been united in one person’s job description: chairing the transaction approval process and their committees, heading the legal compliance and audit group, and serving as Chief Investment Officer for the firm’s principal investing activities.

Mr. Berkenfeld has proven after twentyone years of serving in diverse capacities within the same company that patience and perseverance are key to a successful – and ultimately resilient – career.

HCIM: What advice would you give to college students looking to pursue a career in finance?

It’s important to be patient. Not ridiculously patient, waiting for good things to happen. But I have found

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inside scope

It’s important to work for a firm that will say, “This is basically

”

what you have to do, but if you

prove to us that you can do more, then we want you to do more.”

that many people become a little restless and impatient at the beginning of their careers.

“Why aren’t I moving? Why aren’t I advancing?” I would advise them to take a step back and think of their careers in terms of ten-year blocks, not immediate gratification. This takes time and opportunities present themselves at different times. You just have to feel that you’re making progress by making more of an impact at your firm. Know that sometimes instead of becoming a little restless after a couple of years that it’s better to stick with it, not forcing change. Be patient knowing that your career is going to develop. This can be frustrating for young ambitious businessmen. But again, you want to find a firm that’s willing to allow you to grow and prove that you’re capable of more responsibility. It’s important to work for a firm that will say, “This is basically what you have to do, but if you prove to us that you can do more, then we want you to do more. We want to give you that opportunity.” Find a place that isn’t going to put you in a box with no chance to step outside. The top of the box needs to be open to allow growth and development to your full capability.

HCIM: What principles have you found to be useful throughout your career?

Ethics is a huge factor in doing business at Barclays; one of the principles is to try to do the right thing. It sounds clichéd, but I have an ethical standard that guides my business

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decisions. Doing the right thing is important regardless of whether it involves taking a reputation hit, even when legalities are not in question. This standard of practice extends to include partners, clients, and fellow employees.

This is the foundation to building a successful career. Creativity is also an invaluable tool.

I enjoy the challenge of taking each situation and exploring solutions from every angle possible. Even with solutions that work, I continue to improve them, sometimes approaching them from a total different perspective. I still pride myself on encouraging our committees to consider new and different solutions to problems. It’s not something that I do deliberately or formulaically. It’s intrinsic in how I problem-solve.

HCIM: Now that you are a managing director for Barclays, is there anything you would have changed or have done differently?

No, probably not. I can recall a few specific situations at Lehman that I would have handled a little differently, particular negotiating positions or decisions around deals that in hindsight I might want to have back. But that’s not a career change. That’s very specific about day-to-day advice. I’ve been lucky. I’ve been fortunate because I found a very rewarding, meritocratic place, and now I am able to work in a firm that has continually become stronger, increasingly diverse, and more global.

I find that there are two different career

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paths in broad classification. One is the person who starts at a firm, stays there, and spends his career. And the other bounces around every couple of years, always looking for a new challenge, or an opportunity to quickly increase his compensation or get a promotion. In the course of twenty years he has worked for six different firms. I think in the short term you can do better bouncing around. However, when bouncing from firm to firm, you are constantly given the ball for the first time and must continually prove yourself. And there’s something quite special about the satisfaction you get from growing with a place over the years. The goodwill and credibility that you generate from being at one firm is invaluable.

Everyone knows that you are doing what you believe is in the best interest of the firm. You’re not politically or individually motivated. Your colleagues develop a trust in your decisions.

The best analogy is sports. For example, Mariano Rivera from the Yankees is a legendary Hall of Famer. But occasionally when he blows a save, the Yankees fans don’t boo him.

He’s Mariano Rivera, the MVP responsible for four different world championships. He has created goodwill in New York because he has proven his trust and value to his team. Having that goodwill that is built up over a long period of time lays the foundation for a satisfying, rewarding career.

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inside the profession

An Interview with

Evie Dykema, Founder and Principal of NAVSTAR Advisors

By Yiying Xu

N

AVSTAR Advisors is a Boston consulting firm with the mission of providing a more decisive and efficient version of the structured analysis that helps businesses improve their results in today’s highly challenging business environment. NAVSTAR’s projects range from market-focused research revealing emerging opportunities to client-specific initiatives. Providing services for private equity investors, venture capitalists, operating executives, and hedge fund managers, NAVSTAR helps executives dedicated to identify-

“

ing the maximum point of leverage within a firm or market sector.

The firm’s name, which stands for “Navigation, Strategy, Tactics, And Relay,” was inspired by its NAVSTAR system of 24 orbiting Global Positioning Systems (GPS) satellites that provide accurate navigational information for commercial, consumer, and military applications. HCIM decided to interview Evie Dykema, NAVSTAR’s Founder and Principal, to gain some more insight into the firm.

There was an opportunity to help them access top-tier analytical services at a price that would make sense for middle market companies...

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”

HCIM: Can you describe your personal background and why you decided to found NAVSTAR Advisors?

I’ve been in management consulting for my entire post-MBA career and was surprised to learn from former colleagues who had joined private equity firms that their colleagues rarely invested in such services because they found them to be too expensive. I saw my peers trying to apply consulting principles to improve their processes for buying companies and the success of these operating companies postacquisition – and noticed that they struggled to find time to do this while balancing all of their other responsibilities. There was clearly an opportunity to help them access toptier analytical services at a price that would make sense for middle market companies and the investors who buy them.

HCIM: What distinct advantages do you see in clients seeking your firm for their business needs over larger consulting firms?

NAVSTAR Advisors’ mission is to provide top-tier consulting ser-

HARVARD COLLEGE INVESTMENT MAGAZINE

27

inside the profession vices at a fee that makes sense for middle-market companies and their investors, and to help them realize as strong an ROI as possible on their investment in analytical services.

Our work processes enable us to employ hypothesis-driven analysis more efficiently than larger firms can; in other words, we “find the leverage” more quickly, waste less analytical time, and incur fewer costs to achieve insight.

Larger consulting firms tend to deliver more of a “show” along with their analysis than we do. We focus on the logic that drives business decisions rather than the slides that make presentations sizzle, and we believe that our austere discipline in this respect yields an especially sound set of conclusions and recommended-action steps.

We consider the client’s initial perspectives to be our starting hypothesis, involve them in discussions regarding any new information which would prompt us to revise the hypothesis, and deliver the analysis in a format that encourages them to contribute their own ideas. Our highly structured approach to generating insight yields many benefits for our clients. Larger clients benefit from a working relationship with the type of person that they would normally seek from a Partner at a Bain, BCG, or McKinsey while facing lower prices of engagement; smaller clients can access higher-quality analytical services than they could afford otherwise.

HCIM: Can you describe your specific role at NAVSTAR throughout its growth? Now that NAVSTAR is a well-established consulting firm, how has your role evolved?

The first step was to develop an analytical approach that would deliver the maximum “bang for the buck.” To do this, my colleagues and

28

I reviewed our prior work at various large consultancies and developed a short list of “money slides” communicating the analysis that we felt had generated the most valuable insight for our clients. We then hypothesized faster and more efficient ways to arrive at the same level of insight.

Because there were no established processes for the doing the work that I felt would generate the highest ROI, I was initially involved in absolutely every aspect of the analysis. Once our processes were refined, I was able to delegate responsibility for most of them, in some cases to Harvard students, in others to more experienced professionals, and in one case to someone who developed his own company and team solely dedicated to meeting NAVSTAR’s needs in this area. My current role is to serve as the client’s key contact

HCIM: Do you think business school is essential for a career in consulting?

Although I enjoyed my time at Kellogg, I do not believe that business school is necessary for a career in consulting. Still, it is helpful – especially if you think there’s a chance that you won’t stay in consulting your whole life. A top-tier business school also provides you with opportunities to make contacts that can be helpful to you regardless of which career path you choose; however, there are also other, less expensive ways to develop important contacts.

HCIM: What advice would you give to those interested in opening their own consulting firm one day?

Join a firm that will train you and help you to build your busi-

Always ask yourself how things might be done more efficiently. and ensure that all processes are implemented effectively and adjusted as appropriate.

HCIM: What kind of educational background best prepares students for consulting?

Dykema: Grade point average is critical because it demonstrates two key success factors: intelligence and drive. However, it is also important to remember that business sense and communication skills are critical to effectiveness; consequently, I recommend that Harvard students find ways to enhance and convey these “softer” skills.

HARVARD COLLEGE INVESTMENT MAGAZINE

ness bio, because that’s an important component of what you’ll be selling to prospective clients – and without clients there is no firm.

Also, no matter where you work, always ask yourself how things might be done more efficiently – either to meet the needs of that firm’s target market or another. Also, try to find ways to spend time with entrepreneurs; they have a completely different way of thinking about business than the people you will interact with most in the large consulting firms. The better you understand their mentality, the better a consultant you will be.

WINTER 2009

inside the profession

An Interview with Martin Roll, CEO of VentureRepublic

By Rika Christanto, Former Editor-in-Chief

M

artin Roll is Chief Executive Officer of VentureRepublic, a leading strategic advisory firm on brand leadership. He delivers the combined value of an experienced global branding strategist and a senior advisor to corporate boards and topmanagement teams, many from Fortune 500 companies.

Holding an MBA from INSEAD Business School, Mr. Roll

brings more than 15 years of management experience from the international advertising and branding industry, including DDB Needham and Bates, and is a renowned keynote speaker at more than 100 global conferences annually. Mr. Roll is also the author of Asian Brand Strategy, selected as one of the “Best Business Books� of 2006 by Strategy+Business magazine.

Mr. Roll is a valuable contributor to any senior management discussion on the subjects of leadership, innovation, organizational excellence, and how brand equity drives outstanding performance through shareholder value. HCIM recently met with Mr. Roll to discuss these and other topics related to branding by Asian corporations.

HCIM: Do Asian and Western companies face different challenges in executing their brand strategy?

When Western brands enter Asian markets, they are usually at a disadvantage because of the sheer diversity of market structure, regulatory restrictions, local cultures, customer preferences and buying habits, distribution capabilities and cost pressures. Similarly, when Asian brands enter Western markets, they are usually at a disadvantage because of the highly saturated product categories, hyper-competition, well-entrenched incumbent brands, higher expected standards of quality and service, lack of a clear awareness of the Asian brands, and the possible negative perception about the country of origin of Asian brands (especially those originating from China). As such, Western and Asian brands have fundamentally different challenges in executing their brand strategies.

Western brands face the challenge of a learning curve, whereas Asian brands face the challenge of an education curve. In tackling the learning curve, Western brands will have to quickly learn the ways of operating in highly complex Asian markets, learn about the complexities of distribution (especially given the lack of well established national chains), learn how to handle the regulatory authorities and their ways of working, learn how to establish implementable contracts with local companies in order to gain a better understanding of the customers, and finally learn to customize the Western aspects of a brand to suit the local tastes and preferences.

Similarly, in tackling the education curve Asian brands will have to engage customers aggressively to educate them about the brand, the value proposition of the brand, the brands’ point of parity and differences with the many existing Western brands, to allay fears of the negative

effects of the country of origin, how the brand offers a very strong channel for Western customers to express themselves, and how Western customers can expect more from Asian brands that are striving to establish a presence in the Western markets.

WINTER 2009

HCIM: You emphasize the need

HARVARD COLLEGE INVESTMENT MAGAZINE

29

inside the profession to move marketing higher up the boardroom agenda. How does this happen and how does this translate into a coherent branding strategy?

Whenever branding and Asia are talked about together, there is a sense of both optimism and disappointment. Asia is fast becoming the hottest market in the world and the opportunities are tremendous.

But at the same time Asian companies are not willing to break out of their traditional trading mindset and capture value through branding.

There are many reasons for such a lack of corporate initiative, including the current state of the economy.

Though there is no easy solution to this, a very powerful beginning would be to elevate branding to the boardroom, where it is headed by the CEO and the corporate board. This can be achieved by having a chief marketing officer (CMO) or a chief branding officer (CBO) represent brand management at the boardroom level. Such presence can educate the top management team about the strategic importance of branding and align the branding strategy of the company with the corporate business strategy.

HCIM: Your book, Asian Brand Strategy, focuses on the internationalization of Asian brands.

To what extent are international brands being localized in Asia?

One of the biggest implications of globalization for companies seeking to expand to foreign shores is the task of balancing standardization with customization. When some of the world’s biggest brands expand beyond their home markets, they are tempted to repeat their tried and tested formulas in the new market as well. The assumption is that customers would be too eager to consume the great brand because of its authenticity, heritage, and associations. But this tendency is gradu-

30

ally changing as global companies from the West are learning about the unique needs of the customers in different market along with the pressures of lifestyle, economic, and cultural conditions in Asia.

Glocalization – maintaining the brand logo, the key message, and the underlying philosophy and localizing the brand elements to offer customers an authentic local feel – is increasingly becoming the preferred business model for global brands. By

“

of buying behavior, patterns, and frequency; and (4) improved opportunities to co-create value with the customers.

Brands have always had the problem of generic products and private labels eating into their margins and luring their customers away. But the Internet has added yet another dimension to this age old problem.

There are many websites what collect the minutest of details about many brands in a myriad of product cat-

Branding is not advertising.

Branding is a business ideology.

extending the unique brand experience through customized channels and offerings, global brands seem to be finding a middle path where they can maintain the global brand aura and still appeal to the customers in the authentic local way.

HCIM: What kind of impact are the Internet and other advances in communications technology having on brand leadership?

Once feared as the deal-buster, the Internet has been a blessing for businesses and customers alike around the world. For customers the Internet has (1) minimized the information asymmetry between companies and customers; (2) made price structures more transparent; (3) optimized search and increased product variety; and (4) allowed sharing of customer experiences.

For companies the Internet has (1) made segmentation more efficient and effective; (2) offered a much better pricing mechanism; (3) enabled a much better tracking

HARVARD COLLEGE INVESTMENT MAGAZINE

”

egories, tabulates them and present them to the users. Such a transparent system that allows access to customers is bound to put more pressure on brand managers to better convey the value proposition to the customers.

Branding is not advertising.

Branding is a business ideology.

Branding is a way to corporate strategizing. Branding is an organization wide strategic discipline that is led by the CEO and the corporate boardroom with a single-minded focus to drive shareholder value. Most of those who claim to be branding “gurus” restrict themselves to marketing and its various forms and advertising at the mid-management level. Most “brand gurus” fail to engage the boardroom at strategic level.

This is the biggest challenge for the marketing profession.

For more information, visit Martin Roll’s website at www.martinroll. com.

WINTER 2009

investing today

how to be

“One Up on

” Wall Street

Peter Lynch outlines the 9 Fundamentals of Investing.

By Kamoy Smalling

O

n April 24, 2008, Mr. Peter S. Lynch, one of the greatest stock pickers in the world, came to Harvard to share some of the secrets behind his repeated success at beating the markets.

Mr. Lynch earned his Bachelors Degree from Boston College and a Master of Business Administration from the Wharton School of the University of Pennsylvania. In 1966 he became an analyst at the international investment management firm Fidelity Investments. He is best known for his work as the director of research of the Fidelity Magellan fund. When Mr. Lynch took charge of the fund in 1977 it had a total of $18 million in assets.

Under his management, the fund had an average annualized return of 29.2 percent and only underperformed the S&P 500 twice. By the time Mr. Lynch resigned as fund manager in 1990, the fund had swollen to an astounding $14 billion in assets with over one thousand individual stock positions.

Mr. Lynch is the author of three successful investing books, One Up On Wall Street, Beating the Street, and Learn to Earn, as well as a writer for Worth magazine. AdWINTER 2009

ditionally, he is a very active philanthropist. His Lynch Foundation, which had a value of $74 million in assets as of 2003, focuses on improving education in the inner city, religious organizations, cultural and historic organizations, hospitals, and medical research.

So, how does one beat the street?

Mr. Lynch says it is rather simple.

The key is to follow these nine fundamentals of investing.

1. Know what you own.

It is essential to try to understand the company you want to invest in. What is its specialty? What is it selling? How does its product work? What is its vision and how is it going to get there? When faced with the opportunity to invest in some incomprehensible, cutting edge product, Mr. Lynch instead chose to put his money into Dunkin’ Donuts.

Although a company or product may sound fancy, Mr. Lynch warns, “If you can’t understand it, you probably shouldn’t buy it.”

2. I t is futile to predict the economy, interest rates, and the stock market.

Instead of wasting time trying to

predict what the markets are going to do, Mr. Lynch suggests you learn more important economic information, like the fact that the stock markets go up and down seven to eight percent each year.

3. You have plenty of time.

Good companies can be hard to find, but luckily you don’t need a lot of them in a lifetime to be successful.

It is better to place long-term investments in a few good stocks than to constantly search the market for quick returns on questionable stocks.

According to Mr. Lynch, “all you need is 1 or 2 good stocks a decade, not once a week.”

4. B eware of the nine most dangerous things people say about stock prices :

(Check out the sidebar on the next page.)

5. Avoid long shots.

Make sure you can identify at least one real and valid reason to invest in a stock.

6. Importance of management.

While management is important, it is the company and industry

HARVARD COLLEGE INVESTMENT MAGAZINE

31

investing today

The Most Dangerous Things People Say About Stock Prices: “If it has fallen this much already, it can’t go much lower.” Don’t be fooled by this; When stocks start to fall, they can keep falling.

“If it’s gone this high already, how can it possibly go higher?” If earnings keep going up, stocks keep going up.

“Eventually, they always come back.” Saying that the stock price is going to go back up does not mean it actually will go up. Companies do go bankrupt.

“It’s $3.00; how much can I lose?”

Although a stock might look like a bargain because of its low a company belongs to that really matters. Invest in simple, promising companies: “I want to buy a company any fool can run because eventually, one will.”

price, you should still examine the company and its balance sheet closely before investing in it.

“It’s always darkest before the dawn.” According to Mr. Lynch, “It’s always darkest before it gets pitch black.” Don’t buy a stock just because it’s going through a rough time.

“When it rebounds to $10, I’ll sell.” If you believe a stock is rebounding to $10 and it is currently at $5, instead of planning to sell at $10, plan on buying more of the stock.

“Conservative stocks don’t fluctuate much.” Just because a

7. B e flexible.

Try not to be too quick to invest in rapidly growing companies with the expectation of making a lot of money. Instead, consider investing in a company that is initially shrinking but has large growth potential

8. When to sell.

“When to sell is actually when to buy.” Once again,

company calls itself ‘conservative’ doesn’t mean its stocks are immune to the volatility in the markets. It is important to watch all the stocks you own, even the ‘conservative’ ones.

“Look at all the money I’ve lost because I didn’t buy it.” Don’t worry about stocks you don’t own, focus on the ones that you do.

“The stock has gone up, so I must be right.” There is a 100 percent correlation between company earnings and stock performance. Revenue is therefore one of the best indicators of stock performance.

Lynch emphasizes the importance of your stock’s story. Write down at least three simple reasons why you want to buy the stock, reasons so simple that they can be explained to a ten-year-old. Reasons like “the stock is cheap” or “the price is growing rapidly” should not be included in your story. Check out the company, evaluate it, and create a stock story.

9. There is always something to worry about !

While there will always be a reason to exit the stock market, such as the threat of recession, there will always be a reason not to, such as promising opportunities in the foreign markets. Sometimes it is best just to follow your instinct rather than overthink the market.

32

HARVARD COLLEGE INVESTMENT MAGAZINE

WINTER 2009

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Harvard College Investment Magazine is a semi-annual

publication devoted to presenting the pertinent and current issues in corporate finance, corporate governance and investment research, serving as a platform of intellectual exchange on investment between Wall Street professionals and the Harvard community. Harvard College Investment Magazine is officially recognized by Harvard College with the purpose to educate both Harvard students and the greater community about the pressing topics of investment.

From its inception, Harvard College Investment Magazine has stayed true to its purpose by blending professional articles, interviews, and academic research to offer a comprehensive array of commentary to the investment field, making the magazine accessible to students, investors, and businesses.

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Summer 2008 Issue The Business of Bling Alternative Asset IPOs Interview with Shorebank Executives

Luxury fashion and our consumer society Hedge fund and private equity firms look towards public markets

Notable Previous Interviews Jeff Bezos Warren Buffett Joe Moglia Thomas Monahan III W I N T E R • • • • •

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Door-dropped at Harvard College Delivered to media distribution centers at Harvard Business School, Law School, and MIT. Distributed at the beginning of the Recruiting Period for full-time hires Promotion: Student Activities Fair, various student organizations

U niversity H all , F irst F loor

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