Becoming a value manager is not a mysterious process that is open to only a few. It does require, however, a different perspective from that taken by many managers. It requires a focus on long-run cash flow returns, not quarter-to-quarter changes in earnings per share. It also requires a willingness to adopt a dispassionate, value-oriented view of corporate activities that recognizes businesses for what they are—investments in new productive capacity that either earn a return above their opportunity cost of capital or do not. The value manager’s perspective is characterized by an ability to take an outsider’s view of the business and by a willingness to act on opportunities to create incremental value. Finally, and most important, it includes the need to develop and institutionalize a managing value philosophy throughout the organization. Focusing on shareholder value is not a one-time task to be done only when outside pressure from shareholders emerges or potential acquirers emerge, but rather an ongoing initiative.
The process of becoming value-oriented has two distinct aspects. The first involves a restructuring that unleashes value trapped within the company. The immediate results from such actions can range from moderate to spectacular; for example, share prices that double or triple in a matter of months. At the same time, the price to be paid for such results can be high. It can involve divestitures and layoffs. Management can avoid the need for cataclysmic change in the future by embracing the second aspect of the managing value process: developing a value-oriented approach to leading and managing their companies after the restructuring. This involves establishing priorities based on value creation; gearing planning, performance measurement, and incentive compensation systems toward shareholder value; and communicating with investors in terms of value creation.
By taking these steps to ensure that managing value becomes a routine part of decision making and operations, management can keep the gap narrow between potential and actual value-creation performance. Consequently, the need for major restructuring that goes with large performance gaps will be less likely to arise. Those who manage value well can guide their companies in a series of smaller steps to the higher levels of performance that even the most comprehensive of restructurings cannot match.
We illustrate the integrated application of value management principles by presenting a case example distilled from the real-world experiences of client executives with whom we have worked. Our purpose is to show the process of transforming a company in terms of value to shareholders and management philosophy.
The very term may for some conjure up the devil incarnate. There is little question that the image of the hedge fund has changed over time. Before we get onto that image, let us first deal with what they do. The first thing to say is that there are hundreds, if not thousands, of different types of hedge fund. The term “hedge fund” is in fact an extremely vague one, encompassing the activity of a very wide variety of funds that trade in currency and asset markets. Certain specific hedge funds may seem particularly synonymous with the term, but while their funds are some of the largest they are in fact the tip of the proverbial iceberg in terms of reflecting this section of the financial community.
For a start, most of them unlike their name do not hedge. Indeed, their aim is to take asset market or currency views, to increase risk albeit selectively rather than to hedge risk. Rather than tie up balance sheet capital through spot positions, they frequently use derivatives to express a view, using leverage. The amount of leverage that hedge funds are allowed to use has decreased significantly since the failure of LTCM in 1998. Hedge funds are still active participants in the currency markets, though their involvement has in fact diminished substantially for a number of reasons. Firstly, the LTCM failure caused the counterparties of hedge funds — the banks they dealt with — to take a broadly more conservative approach with regard to credit and leverage given to the hedge funds. This in turn reduced the ability of hedge funds to take on the large, leveraged positions they had in the past. Secondly, the global equity rally (i.e. bubble) in 1999–2000 represented a competitive threat to this sector of the financial community. Hedge funds achieve popularity with investors precisely because of their outperformance to “the market”, that is to the traditional equity and fixed income markets. Thus, when equity markets were exploding higher in 1999, it became extremely dif?cult for some to achieve that outperformance, particularly when this took place at a time of deterioration in the relationship between hedge funds and the rest of the financial markets in the wake of LTCM. Thirdly, the larger a fund becomes the more unwieldy it can become in terms of its market positioning. Benchmarks have to be outperformed and that can be achieved only with size when traditional markets are performing well. Yet, to do that may lead to market disruption, both on the way in and on the way out, reducing the attractiveness of taking the original position. In the end many hedge funds became trend followers in 1999, buying the NASDAQ and running with the crowd, more with the aim of defending returns than generating greater returns. Currency speculation is generally less attractive during times when traditional asset markets are trending so clearly, given that a fundamental part of currency speculation is tofind economic imbalances — positive or negative — that the markets are not pricing in and trade on those in the expectation that the markets will eventually realize such imbalances and trade their way. Several hedge funds reduced their currency speculating operations in 1999. This decision may have been somewhat premature. The bursting of the equity bubble in 2000 has brought hedge funds the opportunity to add value once more, including doing so by means of currency speculation. Indeed, it would not have been difficult to beat the NASDAQ’s return in 2000 and the first half of 2001! Equally, while there may have been a reassessment of hedge funds in the US, both from within and without, the hedge fund community has blossomed and flourished in Europe subsequently, particularly in several countries in continental Europe. The umbrella term of “hedge funds”, even those that focus on the same asset or currency or have the same trading style, can reflect a variety of different types of organization. Recently, a number of total return or leveraged funds have been created. These may have not have a strict mutual fund structure, which helps at least to give some definition to the traditional hedgefunds one thinks of, but they do have a very similar trading approach. In addition, banks can have internal hedge funds for specific client products. In sum, there are a very large number of hedge funds that “speculate” in a large number of assets and currencies. The performance of speculative currency funds is measured by a number of organizations, including the MAR (Manager Accounts Report) Trading Adviser data (available at: www.marhedge.com), Parker Global (www.parkerglobal.com) and the Ferrell FX Manager Universe. The irony with regards to their critics is that most base their trades either on inconsistencies in market pricing, which can instantly be arbitraged, or on sound macroeconomic principles. This latter group, known as the “macro” hedge funds, make up by far the largest group of funds that are publicly known. They are speculating according to fundamental principles. Thus, one could argue they are not speculating at all.
While many may seek to make a clear distinction between speculative and non-speculative activity, any such line of distinction is frequently uncomfortably blurred. At its most basic level, there is the idea that corporations take currency positions purely for transactional or hedging purposes, while hedge funds or prop dealers take currency positions for directional gain, with no underlying asset. The idea that there is such a clear distinction between the two sides is a fiction. Over the last decade, several major corporations have experienced painful losses and some have even collapsed as a result of taking on financial market positions that subsequently went sour. In this regard, problems tend to start when financial speculation overtakes the underlying business in importance.
Whatever the case, there are therefore other currency market participants we need to examine, which can at times be considered as currency speculators. Though many would no doubt bristle at the term, that is what they are if the individual transaction they are conducting has no related, underlying asset.