Last Monday, the world lost Stephen R. Covey, a pioneering speaker and author on the subject of principle-based leadership. Covey was perhaps best known for his 1989 book, The Seven Habits of Highly Effective People, which helped usher in a significant sea of change in business literature. Prior to the articulation of the seven habits, the archetypical business book was In Search of Excellence, with its strong focus on management practices and corporate strategies. By contrast, Covey focused on prioritizing effectiveness through principles of self-management, and his seminal work opened the floodgates for all the primal, resonant, and level five good-to-great leaders that would follow.
Though Covey’s Seven Habits sold more than 20 million copies, and though his firm would advise 90 percent of the Fortune 100 and 75 percent of the Fortune 500, he considered his greatest inspiration and legacy to be his wife, children, and grand-children, of whom he was survived by fifty-two! He was known for his great personal warmth, and the equal kindness he would show to the multinational’s CEO and the local barber.
Stephen Covey wasn’t writing directly about hedging or derivatives, but he might as well have been. His lessons have not only helped countless millions down the path to personal and professional success; they have also formed the framework by which the most successful business risk managers – those highly effective hedgers – have visualized and carried out their protection programs. In honor of Stephen’s legacy, then, we’d like to share with you how proactivity, clear purpose, understanding, and renewal translate into the world of hedging, many of which principles you may already know and embrace.
1. Be Proactive. Covey argued that proactivity emanated from a strong commitment to take control of one’s life. In his parlance, a proactive person would tackle things he could reasonably expect to change, like health habits or issues at work; by contrast, a reactive person couldn’t do much because he was worried about intangible or uncontrollable things like the weather. Similarly, a highly effective hedger proactively considers the nature of company risk and how to manage it. Whereas a reactive hedger might say, “Who can possibly know what will happen in the Eurozone; let’s not take any action until there’s clarity,” a proactive hedger says: “Let’s consider all the plausible scenarios and war-game how we would be affected by each one.”
2. Begin with the End in Mind. Remember the words of Covey: “Be sure that, as you scramble up the ladder of success, it is leaning against the right building.” Whether in personal or corporate objectives, it is not success but failure to pursue and reach the wrong goal. In the same way, a highly effective hedger never hedges without starting with the very end in mind, for instance: “I’m buying a hotel in Madrid and I intend to hold it for 4-6 years. Given the euro’s recent dip, I’d like to participate in any upside potential on the currency, and I don’t have any upfront cash available to hedge my equity.” When a hedger begins with the end in mind, the desired outcome frames the best risk management.
3. Put First Things First. Covey famously wrote in First Things First, “The main thing is to keep the main thing the main thing.” In his thinking, this habit unified the first and second habit, because no one has enough time to be proactive and end-goal oriented about everything. Thus a highly effective hedger will spend the time to ensure that she is optimizing the most important risk management objectives. Does a known fixed rate for the life of the financing matter most? How about the avoidance of painful breakage costs if the asset sells before the hedge matures? What level of protection will make or break the deal? Is it more important to protect deal economics or remeasurement risk? Would the application of good hedge accounting be merely nice to have or a sine qua non?
4. Think Win-Win. In this habit, Covey advocated discarding endless comparisons and the zero-sum game mindset for an abundance mentality. For instance, he encouraged changing the paradigm of negotiation from competition to collaboration towards a mutually beneficial solution. So how does this play out in hedging? If someone makes a speculative bet on corn futures, that person will indeed be caught in a win-lose scenario; if demand for corn drives up the price, the trade makes money; if corn is over-produced, the trade will lose money. By contrast, a highly effective hedger who harvests corn faces a win-win scenario. Either the corn increases in value, or the hedge pays off to protect him from its decrease in value.
5. Seek First to Understand, Then to be Understood. Covey wisely noted that people spend years learning to read, write, and speak more effectively, but hardly anyone is a practiced listener! Too often, we don’t wait to hear what our interlocutor wants to say before interjecting our own perspective. In the world of hedging, Chatham often gets engaged to sort out the aftermath of the usage of highly structured and exotic derivatives. In many cases, if the purchaser had sought first to understand well enough to explain clearly to someone else how the derivative would behave, the trade never would have happened. Understanding a derivative’s payoff clearly, and especially its behavior in a variety of market duress or shock scenarios, could prevent a lot of derivatives misuse and lead to more highly effective hedging.
6. Synergize. The word “synergy” could fairly be termed a business buzzword bereft of meaning, but it surely was not in 1989 when Covey codified the seven habits. As he argued, the goal was not leaving dependence on others for total independence, but rather interdependence to produce the greatest results possible through creative cooperation. In a similar fashion, a highly effective hedger does not merely think about one exposure or risk in isolation, but rather the interdependencies and interconnectedness of the entire consolidated financials. Hedging each risk in a piecemeal fashion is far more costly, and ultimately less effective, than understanding all of the natural offsets that reduce the hedging notional required. Additionally, individual commodities and currencies move in a correlated fashion, and so the right hedge cannot be determined without calculating their complex interplay. Highly effective hedgers know that optimized risk management relies on the synergistic behavior of each one.
7. Sharpen the Saw. Covey begins his discussion of the 7th habit by relating the story of a man who had been trying in vain to cut down a tree for five hours, explaining: “I don’t have time to sharpen the saw. I’m too busy sawing!” He advocated focus on personal renewal, which would create an upward spiral of continuous improvement. So for the highly effective hedger, what can create this upward spiral? First, strategic investment in the right technology or external hedging advisor relationship can make risk management decisions much sharper and more precise. More generally, highly effective hedging strengthens every part of the business. When commodity inputs to cost of goods sold are appropriately hedged, corporate budgeting is more accurate, sales targets can be calibrated, prices can be set with clearer profitability targets, and shareholders see a more stable picture, to name a few. There is a self-reinforcing feedback loop which brings greater effectiveness in pricing, in sales, in budgeting, and in investor relations.
Part of the legacy of Stephen R. Covey is that his central ideas still have great relevance today, and that his framework is still a useful one for calibrating both personal endeavor and professional focus. At Chatham, we find one of his statements particularly compelling: “People can’t live with change if there’s not a changeless core inside them.” If anything you’ve read in the above makes you want to be a more highly effective hedger, please give us a call! We promise to seek first to understand before trying to be understood. +1 610.925.3120.