Just Stick to Your Rules - Evidence From the Financial Crisis
The first article I have written (1), is a concise summary of the book about the same subject: the parallel between investment management and business management.
The idea is simple; in business management as in investment management managers are continuously seduced by information, new products, new market opportunities and other ideas and possibilities that come from the outside. In business management managers often hold on to a strategic plan which they design and continuously evaluate. In investment management, the manager may have a similar plan that guides him or her through the market developments.
The strategy comes from within, from capabilities; the market turbulence is a given fact every company and manager has to live with.
The problem with this strategic-approach is that it takes long to set up and it is hard to align with market developments. How do you know for example whether you are not just following the market developments and whether the strategic plan changes with the fluctuations in the market developments?
An alternative to this planned approach is to focus on preferences. These preferences can be communicated by a set of rules and with these rules the investor or business managers, determines whether a opportunity is really that or something that doesn't fit the company profile or logic.
A question someone asked recently was about this: how do you know whether you have done the right thing? How do you know that your rules have worked for you?
Probably one of the best examples is the recent financial crisis. Interesting about the crisis is that both business management and investment management have been subject to the crisis.
The business manager of the bank may have followed the rules and decided that over investing in sub-prime became too risky for the company profile. By doing so it would miss a market opportunity, where other parties have gained much more when following the market. The other side is that those who have followed their own rules wouldn't end up in problems either. They have missed a percentage of the rally, but they have gained substantial in not having to write-off bad loans. Additionally the market has punished those parties that have taken too much risk, and the same market has labeled these companies as more risky (AA-rating, etc).
The paradox is that the market is misleading. At one stage it signals to follow a trend. The next moment the same market punishes companies that have over exposed their risk. Therefore managers need their own rules.
Companies and business managers that "have followed their rules," are not affected.
A lesson is that in many cases only afterwards you know for sure when you shouldn't have followed the market opportunity. But then it is too late. Following the market is always tempting and the easiest to do (follow others...). A strategic plan will not help you solve such a dilemma, the only thing that will guide you in such circumstances is judgment about what you are and about the rules you use to either follow the market or you own judgment. This requires real leadership.
H.J.B.
(1) - http://ezinearticles.com/?Management-of-Growth---Just-Stick-to-Your-Rules&id=74233
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