Becoming a Values-Based Leader

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CFA Chicago’s Distinguished Speaker Series recently hosted Harry Kraemer, an executive partner with Madison Dearborn Partners and Clinical Professor of Strategy at Northwestern University. Former Chairman and CEO of Baxter International Inc., Mr. Kraemer is author of the book, “From Values to Action: The Four Principals of Value Based Leadership”.  He spoke of the critical need to develop the next generation of leaders and of the “Four Principals” as illustrated in his book.

Mr. Kraemer stressed that leaders need to begin leadership early in their career showing that they want to be “in” the movie, not just “watch” the movie. Leaders must not be content to wait for “those guys” to make decisions; they must want to be one of “those guys”.

In order to influence people, leaders must be able to relate to people. They must also be able to employ common sense and have the ability to make complex problems simple.   It is important to demonstrate these attributes on day one of whatever job they begin.

The “Four Principals” of value based leadership are “Self Reflection”, “Balance”, “True Self Confidence”, and “Genuine Humility”.  In his presentation, Mr. Kraemer went on to describe each principal as follows:hklogo_head

Self-Reflection: A leader needs to be able to get away from the notion of merely going faster to get more things done.  He needs to be able to determine which tasks really matter and ask what could be done differently.

Balance: A leader must be able to demonstrate knowledge about a wide array of topics. To understand all sides of a story, he must understand other perspectives. The incorporation of multiple perspectives makes it easier to move forward.

True Self-confidence: The ability to say “I don’t know” and the ability to say “I was wrong” is evidence that a leader has true self confidence.  An inability to say these things shows that he is too worried about what other people think.  Everybody has strengths and weaknesses and those must be acknowledged in order to improve.

Genuine Humility: A leader must remember where he came from and how he got to where he is.  Luck and timing can be just as important as skill set and prior work performance.  A leader needs to keep in touch with people who knew him “when”.

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Mr. Kraemer stressed the importance of keeping in touch with a wide variety of people from within and outside the organization. He recommends that mentoring not be limited to one or two confidants, but rather come from a wide array of people.  This exposure makes it easier to determine what values are important.

Mr. Kraemer concluded his remarks by speaking about the One Acre Fund which benefits small farmers in East Africa.  The proceeds from his book sales will go to further the aims of the fund.

Don’t Be Surprised!

On June 25, CFA Chicago welcomed Steve Romick, CFA at The University Club. Romick’s presentation included lessons learned after four decades of value investing, focusing on absolute rates of return. He emphasized the following concepts he employs:

  1. Accept uncertainty
  2. Have a disciplined focus on value
  3. Focus on outperforming over market cycles not calendar quarters

He has deployed this absolute value focus to his New Income Fund.  According to Steve, this fund has never had a negative quarter.  He looks at value stocks like infinite duration bonds with rising coupons. The individual security exposure in his funds is generally limited to between 1% and 3% of the portfolio value, depending on his conviction. His funds are go anywhere funds (similar to hedge funds), providing examples of companies he would not own because he cannot easily quantify how they can generate value.  He also provided an example of a company he does own because the market value of the underlying minority interest in a public company was greater than the parent company’s market value.

Interestingly enough, because their goal is to out-perform over economic cycles, he no longer puts significant resources in trying to predict the economy.  He says he wins by not doing dumb things and by always having a rational value thesis. Both he and his team always strive to take off the rose color glasses when looking at an investment, with an emphasis on what could go wrong.

Steve reminded the audience that the U.S. market is at an all-time high relative to GDP and that the current bull market is the longest, since World War II.  This may be a somewhat compelling reason to be focused on value investing.

Steve Romick, CFA is Co-Managing partner of First Pacific Advisors, LLC, a Los Angeles-based investment manager.  Romick is a value investor with a proven ability to build strategies with an absolute return focus that have generated superior risk-adjusted returns over full market cycles. Romick earned a BS in Education from Northwestern University and is a CFA Charterholder.

Investing in a Changing Climate

Investing in a Changing Climate

Is climate change for real? The short answer is yes. According to Doug Sisterson, co-author with Seth B. Darling of How to Change Minds About Our Changing Climate…about 98% of climate scientists believe that the Earth’s climate systems are changing due to “anthropogenic” (caused or produced by humans) greenhouse gas (GHG) emissions.

Based on peer-reviewed scientific reports, The International Panel on Climate Change (IPCC) concludes that the effects of greenhouse gas emissions, and their anthropogenic drivers, are extremely likely (95% – 100%) to have been the dominate cause of global warming since the mid-20th century in its Climate Change 2014 Synthesis Report Summary for Policymakers (4). The IPCC describes the causes of climate as follows:

SPM 1.2 Causes of Climate Change

“Anthropogenic greenhouse gas emissions have increased since the pre-industrial era, driven largely by economic and population growth, and are now higher than ever. This has led to atmospheric concentrations of carbon dioxide, methane and nitrous oxide that are unprecedented in at least the last 800,000 years. Their effects, together with those of other anthropogenic drivers, have been detected throughout the climate system and are extremely likely to have been the dominant cause of the observed warming since the mid-20th century.  {1.2, 1.3.1}” (4).

The IPCC presents an interesting graphical view of GHG emissions (in gigatonne of CO2-equivalent per year, Gt CO2-eq/yr) for the period of 1970 to 2010 (shown below). Interestingly, annual CO2 emissions from fossil fuel combustion andindustrial processes accounted for 65% of the 49 Gt total. Other major sources include methane (CH4) at 16%, CO2 from Forestry and Other Land Use (FOLU) at 11% and Nitrous Oxide (NO2) at 6.2%.

What are the risks of climate change?

The risks associated with global warming are expected to create widespread impacts across the planet—and include more severe weather-related events. In Asia, IPCC identifies increased drought-related water and food shortages, more heat-related human mortality and increased flood damage to infrastructure, livelihoods and settlements. Europe faces increased damage from river and costal floods, increased water restrictions and increased damage from extreme heat events and wildfires. North America faces similar problems with increased damage from wildfires, increased heat-related human mortality and increased damage from river and costal urban flooding. The oceans face reduced fisheries catch potential, mass coral bleaching/mortality and increased damage from costal inundation and loss of habitat (14). While this is not an exhaustive list, the point is that the effects are widespread and can impact human health, agriculture, housing, infrastructure and many other industries too—think of massive insurance claims after extreme weather events.

What’s the global plan?

In order to limit the harmful effects of global warming, The United Nations Framework Convention on Climate Change (2010) established a global accord in Copenhagen that attempts to limit the future increase in global temperature to 2 degree Celsius from pre-industrial temperatures. Since scientists estimate an almost linear relationship between cumulative CO2 emissions and projected global temperature change to the year 2100; this effectively means that a “carbon budget” on CO2 emissions has been established between 430 to 530 Gt CO2. The graph below illustrates the relationship between the carbon budget (CO2 emissions permitted below a 2 degree temperature increase) and climate change.

Problem solved?

Not so fast. Under this carbon budget, the International Energy Agency (IEA) reports that no more than one-third of proven fossil fuel reserves can be consumed prior to 2050, unless carbon capture and storage (CCS) is widely deployed in its 2012 World Energy Outlook.

No more than one-third of proven reserves of fossil fuels can be consumed prior to 2050 if the world is to achieve the 2 °C goal, unless carbon capture and storage (CCS) technology is widely deployed” (3).

This dilemma has led some to conclude that fossil fuel reserves may become “stranded assets” that won’t or can’t be used in the future—which could lead to asset write downs (impairment) on balance sheets and imply that current stock prices are overvalued. The Carbon Tracker Initiative notes that assets can be stranded for regulatory, economic or physical reasons.

Stranded assets are fossil fuel energy and generation resources which, at some time prior to the end of their economic life (as assumed at the investment decision point), are no longer able to earn an economic return (i.e. meet the company’s internal rate of return), as a result of changes in the market and regulatory environment associated with the transition to a low-carbon economy.” Carbon Tracker Initiative: Resources: Stranded Assets, Web. June 2015.

However, according to Julie Fox Gorte, Ph.D., senior vice president for Sustainable Investing at Pax World Investments, “Factually, unburnable carbon doesn’t exist.” In short, Dr. Fox Gorte correctly points out that in order for fossil fuel reserves to become stranded (unburnable) assets there would need to be new regulations that don’t exist today in Pax World’s ESG MattersEven still, I believe new environmental regulations, legislation and carbon markets will develop and we must pay very close attention to them.

I know of no nation that has or is considering legislation to make it either illegal or uneconomic to extract remaining coal, oil or natural gas reserves and burn them in the engine of commerce, mostly to produce energy” (1).

What can investors do? 

First, recognize that the problem is real. Second, understand that the timing, magnitude and consequences of climate change are evolving issues. Consequently, one could develop an investment strategy that evolves as new scientific information, technology, environmental markets (for greenhouse gases, carbon, water, weather risk, etc.) and legislative or regulatory policies emerge.

Many colleges, universities, foundations, cities and other civic, charitable and religious institutions have opted to divest from fossil fuels (see Go Fossil Free Divestment Commitments). Others have opted to influence change through corporate engagement. And still others use low carbon indexes to increase exposure, while reducing tracking error, to more carbon-efficient companies (seeMSCI Beyond Divestment: Using Low Carbon Indexes).

Finally, let’s not forget that climate change will create new investment opportunities and environmental markets. Surprisingly, the best trade can be counterintuitive.Richard L. Sandor, Ph.D., Chairman and Chief Executive Officer, Environmental Financial Products, LLC, recently talked about his new book Sustainable Investing and Environmental Markets: Opportunities in a New Asset Class by authors Sandor, Clark, Kanakasabai and Marques in Chicago. Sandor explained that environmental markets often over-estimate the cost of compliance with new regulations so the best trade could be to short the carbon market—even though your gut is telling you that the price will go up.