By: Luis Arciniega

How many people do you know that follow the same route to go from their home to their work place? Or that despite the fact that they renew their wardrobe frequently it seems that they always wear the same clothes? Or those that when they are informed that to make a process in their company a new procedure has been implemented, immediately get furious regardless of the fact that the change will save time and work? Certainly more than one person close to you shows this kind of behavior. However, it is curious that if you start thinking about their ages, they will be people that need more than two puffs to blow out all the candles in their birthday cake; you will also be able to identify cases of individuals who never let go of their laptop and their handheld device to go everywhere and that nevertheless they frequently display the behavior described above. An interesting thought would be to start thinking about the common denominator that characterizes these persons: a personality trait? their genes? their education?

It has recently been suggested that persons can naturally be predisposed to resist changes. All human beings have a greater or lesser degree of this natural opposition to anything related to change. This psychological variable called Dispositional to Resistance to Change (DRT) is not simple, it has different dimensions that may or may not appear simultaneously. The four heads of the monster have their respective first name and last name: routine seeking, emotional reaction, short term focus and cognitive rigidity.

The routine seeking refers to the trend people have to try to set patterns in everything they do, in order to reduce uncertainty and minimize their stress. Some descriptive behavior of this facet could be exemplified in a person who every day at 13:25 hrs. sharp closes his desk, goes to the restroom and from there takes the elevator to go to have lunch, enjoying in advance the fish with mashed potatoes – the dish that he normally eats that day of the week – dressed in his blue suit with light white lines – the suit that he repeatedly uses on Wednesdays-.

The second facet of DRT is the most affective of them all and it has to do with the negative systematic reaction of persons before everything that implies a change. Everything that is related to a change, regardless of how simple it is, will automatically generate a reaction of nuisance in the person and shall be accompanied by clear negative gestures and, of course, of verbal expressions that state the person is upset because of the change. This may go from something that is as elemental as facing a new security provision in his company, to having to pass his ID card chip by the entrance turnstile, park his car in a different slot in the parking lot, up to something that is more important, as could be a change in position. This DRT dimension is called emotional reaction.

The short term focus is related to the persons being set on criticizing and stating their inconformity and being upset with all the negative issues the change will generate in the short term, instead of visualizing all the benefits it will bring once it has happened; for example, being involved in a 14 month project, in which the migration of the use of 80 unrelated systems to an integrating platform such as an RP, will take place. The employee is more worried about the many meetings and extra hours he will be involved in during 14 months, than in all the time, effort and stress the RP will save him, after it has been implemented.

Cognitive rigidity has to do with the lack of flexibility of people to think and accept new ideas, methods or alternative ways of doing things. If the words stubborn or fool have crossed your mind it means that you have properly understood what you read in this fourth dimension.

It is very likely that any reader with a transcultural mentality will immediately think: how universal can these dimensions be and, on the other hand – in line with the fashion of comparing our productive future strength with that of other nations -, how resistant to change are we Mexicans versus other inhabitants of other regions of the planet. Unfortunately, since the appearance of the PISA study in 2002 (comparative study made by the OECD), we live with the shadow of appearing always in the last places, in work skills competences required in the current world by organizations. That is why the last question is twice as interesting, since if companies demand collaborators with low resistance to change, what kind of people joins the productive force of our country.

In order to answer the questions posed, herein below is a brief description of the results of a couple of international studies made of 4,201 young Administrative Economic Sciences college students of 17 countries who today are part of the productive force of the planet. The Mexican sample was formed by 265 students from three different universities, one in Merida, another one in Tampico and a third one in Mexico City; the first two are public universities and the last one is private.

Table 1 Comparative Table of the Disposition to Resistance to Change in 17 countries (1)

The bold numbers in red reflect the higher mean, while the bold in blue the lowest. This table was prepared with data collected by a researchers’ team in 17 countries. See references: Oreg, et al 2008 and 2011.

On the first question – if the four DRT dimensions or facets exist or mean the same thing in different cultures – the answer can openly be yes given that both studies used multivariate vanguard statistic techniques and reveal that the four dimensions are clearly identifiable in the 17 countries and that they have similar meaning. To do the above, a questionnaire meticulously adapted to 14 different languages, Spanish being one of them, was applied.

Regarding the second question, the table of results the mean of each of the 17 countries samples in each of the four facets of DRT is reported. In all cases the score is between 1 and 6. It is important to note that the higher the average, the higher is the disposition to resist changes. As can be seen the Mexican sample together with that of the Czech Republic had the third lowest average in routine seeking, while the China sample had the highest mean and Croatia the lowest

México also showed the second lowest average in emotional reaction, while Norway had the lowest average and the Japanese simply the highest. Regarding the short term focus, the Mexican sample had the third lowest place, only beaten by the Lithuania and Norway samples. Also see the difference with Lithuania, it is only one hundredth and with Norway 3. At the other end the Japanese sample obtained the highest mean of the 17 countries.

Finally, in cognitive rigidity the Mexican sample won no medals as it was ranked number 12, and had the sixth highest average amongst the 17 countries.

Although the OECD studies show that in reading comprehension and analytical numerical reasoning competence, Mexico has a labor force with significant formative deficiencies, and the results of this study somehow reveal a positive panorama for all the managers and directors who have collaborators reporting to them. Our university students have a low predisposition to resistance to change as compared to other nations, both developed (Great Britain, Japan, and Germany) as in developing countries (China, Turkey).?

References

Arciniega, L.M. y González, L. (2009). “Validation of the Spanish-Language Version of the Resistance to Change Scale”. Personality and Individual Differences, 46(2), 178-182.

Oreg, S., Bayazit, M., Vakola, M., Arciniega, L., Armenakis, A., Barkauskiene, R., et al. (2011). “Measurement equivalence of the dispositional resistance to change scale”. En E. Davidov, P. Schmidt, & J. Billiet (Eds.). Cross-Cultural Analysis: Methods and Applications, pp. 249-278. Nueva York, NY.: Routledge

Oreg, S., Bayazit, M., Vakola, M., Arciniega, L., Armenakis, A., Barkauskiene, R., et al. (2008). “Dispositional Resistance to Change: Measurement Equivalence and the Link to Personal Values Across 17 Nations”. Journal of Applied Psychology,93(4), 935-944.

Por: Antonio Lloret
Professor and Researcher at the Business School, ITAM

Companies can make strategic decisions passively-meaning they replicate some past performance or because they take time to react to changes around them-or actively-meaning they make decisions with a view to the future, promote change ,or react more quickly. Active companies consider the future as a strategic challenge capable of changing current decisions.

When an organization has a competitive advantage over its competitors in the rest of the industry, it is no accident. It is the product of thorough reflection on the set of strategic actions it has taken and will take regarding the use of its resources, trends in its markets, or new product innovation.

This type of competitive advantage has much to do with the company’s capacity to generate both economic and intangible benefits that represent value in the future when they are reflected in the present. A company’s sustainability goes hand-in-hand its capacity to generate value over time. This, of course, depends on its future existence, and because future events may increase or reduce the company’s value, it is important it take these into account.

These future events, whatever they are, may have an impact on the company because executives make decisions either in response to a real event or to the possibility that it will happen. In a perfect world, in which we are absolutely certain of future events, we could analyze the best course of action for the company at every moment. However, in our reality, where uncertainty is an everyday event and decisions made today determine the future of the company, is indispensable that we have the tools for making strategic decisions that generate value at all times. One tool for reducing future uncertainty and maintaining or increasing the value of the company is for the executive and the organization to learn from the future.

But how can we learn from the future if it doesn’t exist yet? The answer is, we have to create it, or parts of it, and simulate possible events, analyzing how these events may generate opportunities or threats for the company and, as a result, take strategic actions to protect ourselves or take advantage of the fact that, if the contingency does occur, the company can not only act immediately, but it can benefit from the circumstances and create a competitive advantage.

Let us assume, for example, that you work for a company in the food and beverage industry, and you are the manager for a brand of fruit drinks. You compete with other companies that also produce fruit drinks. Learning from the future means understanding the main variables around which your business revolves. In our example, some of these valuables may be national or regional trends in the consumption of fruit drinks, the size of the market your company serves, the supply of fruit concentrate and of the necessary ingredients to make the drink, potential regulations, entry of new competitors, etc. We have said that if an organization acts passively or reactively to an event, it could lose the opportunity to adapt to new circumstances. The competitive advantage lies with the company that adapts in the least amount of time to the new climate. In our example, let’s assume a regulatory restriction, in which fruit drinks must have a reduced quantity of sugar or sweeteners per unit. The company that learns from the future should be able to simulate a change in the regulation and take precautions, generate a plan of action and evaluate the implications that such a change could bring to its market or consumer preferences. But the passive company learns only from the past, so it will wait to see the impact of the new regulation and once it understands it, will take precautions. when this happens, the company that learned from the future is already one step ahead, because it has the most efficient response capacity. The passive company will wait for a new opportunity. Learning from the future is precisely an opportunity generator, and it should be viewed as such.

So how can we learn from the future? By designing and simulating possible strategic scenarios, which arise when we analyze how the company would react to various future events, from catastrophes to trends in a relatively well-known variable. We build a scenario in which we posit the occurrence of an event, and decide which actions to take.

Let us return to our fruit drink company and imagine, for example, that the future presents us with a regulatory restriction on calorie content. The scenario would help us to understand how the company would react to this restriction, either by seeking out some sort of substitute sweetener that has a lower calorie content, or by reformulating the beverage to comply with the new regulations.

So what should the company do in the event of a weather-related catastrophe like a hurricane or earthquake? Well, simulating a hurricane is not easy and that is not our task at present, but we can assume that some distribution routes could be closed are flooded and, as a result, we might be unable to serve a particular segment of our market. Learning from the future means, in this case, having a plan of action that reduces the impact of such catastrophes as much as possible and enables the company to maintain supply to all its markets, by finding alternative routes or distribution systems. In short, learning from the future involves simulating the occurrence of an event and generating a plan of action to face it the best way possible, taking advantage of opportunities it may generate and reducing the threats.

To learn methodically from the future, we can sum up the actions to be taken in three phases:

• Prepare an “X-ray” of the company by understanding and knowing what are its strategic assets or the resources and capacities and give it a value. In the example of the fruit drink company, the formula and the distribution chain are indispensable for generating value in the company.
• Identify economic, demographic, political, social, labor or environmental variables that may present an opportunity or threat to the company’s strategic assets. In our example, political variables and environmental factors are some of the elements that may be used to learn from the future.
• Once the variables are chosen, and having understood the conditions under which they might occur, we can generate strategic scenarios. In these, we decide whether the variable in question would have a positive or negative effect on the company’s strategic assets and specific actions or plans of action to implement if that uncertain event materializes.

These three steps can be broken down into greater detail to learn from the future starting today.

To prepare an x-ray of the company, we must be very clear about our strategy, and specifically the type of competitive advantage that our company exploits. For example, do we operate lower costs, or offer greater benefits, or are we different in some other way?

Next, we must evaluate our company’s resources and capacities; this means intangible and tangible resources that allow the firm to create value, like a brand, a plant, the distribution chain, exclusivity contracts, or concessions the company holds, and which are subject to opportunities or threats from future events. The idea here is to distinguish those resources and capacities that allow us to pursue our strategy, in other words, our strategic assets. Without these, we will not get very far.

The next step is to distinguish our agents of interest (vendors, clients, competitors, regulators, substitute and complementary products) in order to understand the industry and its main players so that when we assemble our scenario we can also understand the impact it might have on other players. The x-ray of the company can help us to understand its value generators and those of the main players in the market.

Since we already have a lot of information about the company and its environment, we must now list the uncertainties the company could be affected by in general terms. An important question is whether what the organization does with its value chain could be affected by some event.

This type of analysis could prove tedious because of the wide number of events that could affect the value chain in the future, so our analysis should be limited to the most important variables and a brief description of their effect on the value chain. The list of variables may be:

• Economic (inflation, GDP, devaluation)
• Demographic and social (population growth, change in preferences, dietary trends, ethics)Labor (strikes)
• Environmental (extreme weather, climate change)
• Political and regulatory factors (taxes, trade agreements)

This will help us to distinguish what variables could have the greatest impact on given processes.

To select our variables, we should list them and go over them in different ways while considering how they would affect or benefit agents of interest and out strategic assets. This exercise is useful for considering how important each variable is, because many of them may not be that significant. It is also important that they meet the following criteria:

• That they be relevant (they would change the course of our actions)
• That they are consistent in time (that they exist in a time period relevant to the firm)
• That they are consistent in space (that they have to do with the region or regions about which the firm makes decisions) and,
• That they are exogenous (the company cannot change their course)

With regard to this last point, it is very important to remember that uncertainty comes from without, something that does not depend on the company-otherwise it would be endogenous and controllable. An example of an endogenous event is a company’s financial situation. Although this may be affected by external events, it is not in itself an uncertainty, because it is something internal that the company can improve. Having picked the strongest variables, we then proceed to build strategic scenarios. To do so, we must choose the most relevant pairs of uncertainties for our scenarios. Now we cross pairs of uncertainties and check them for consistency, meaning that they are relevant in combination, that they are not correlated, and finally, that they say something in terms of possible events. Having crossed two uncertainties, we can think of them as coordinate axes on a Cartesian chart and rate each quadrant as positive-positive, negative-negative, positive-negative and negative-positive. For example:

Once the quadrants are mapped out, it is time to prepare scenarios. The idea in creating scenarios is to evaluate the impact of an event on strategic assets. It is best to take each quadrant independently and evaluate whether it is requires strategic action to maintain the company’s value. It is also a good idea to list the repercussions each scenario will have on the agents of interest.

Once we have various panoramas laid out, it is time to evaluate the cost of the actions that may be taken. For example, the cost of formulating a new beverage with lower caloric content or developing new distribution routes. Finally, once we have developed scenarios with various pairs of alternatives, we should go over the actions that appear in several the scenarios and then decide whether or not it is worth taking them. For example, if our scenarios repeatedly reveal a need to establish an alternate distribution route, this may well be an action that would be worth the trouble to implement, regardless of whether or not the event actually occurs in the future.

Generating and simulating future events is not an exercise that should lead to paranoia. It is important to see that the future is a great ally, and learning from it is an opportunity generator.?

References

Courtney, Hugo; Kirkland, Jane; & Viguerie, Patrick (1997), “Strategy under uncertainty,” Harvard Business Review, vol. 75, no. 6, pp. 67-79.

Schoemaker, Paul (1995), “Scenario planning: A tool for strategic thinking,” Sloan Management Review, vol. 36, no. 2, pp. 25-40.

By: Ana María Díaz

The risks and drawbacks facing NGOs in Mexico are mainly of a financial and regulatory bent, and tend to affect mainly organizations with weaker structures, undermining their ability to produce the desired results and, in some cases, threatening their very existence. Some of the problems most often encountered include: the absence of a regulatory framework, inefficient management systems and budget controls, inefficacy of the projects undertaken and lack of transparency in the rendering of accounts, while the poor performance of such organizations can be indirectly attributed to Mexico’s incipient culture of donation.

The term “Non-Governmental Organization” or its abbreviated form “NGO” became generalized when the UN wanted to distinguish between specialized inter-governmental entities and private organizations. NGOs are civil society organizations created by volunteers independently of local, regional and national governments and international organizations in response to needs not met by the State. Their goals and purpose are defined by their volunteers, who champion a specific cause, commit to a series of humanitarian undertakings, make governments aware of society’s concerns and oversee programs to ensure these are implemented in accordance with established policies.

The NGO sector goes by many different names, with its organizations being dubbed voluntary, non-profit, charity, social economy and civil society enterprises. More recently, the trend has been to refer to this as the “third” sector. In each country, civil society organizes itself differently, depending on its specific history, economic context, social and cultural structure, and regulatory and legal frameworks. These factors have given rise to a great diversity of organizational structures that reflect the idiosyncrasies of the country in question.

In the case of Mexico, Catholic and charity organizations had a marked influence on some of the organizational structures and forms the country’s NGOs take today. It wasn’t until the 1980s that civil organizations and society at large began broadening the scope of their actions, with the individualist concept of social welfare giving way to a broader, more comprehensive one in which the community assumes greater responsibility and plays a more active role in programs and coordinated government efforts. In the 1990s, Mexico joined the global social development movement, which is when organizations of this type began to seek legal status.

The term “NGO” is not a legal concept per se. Under Mexican law, non-profit organizations are deemed artificial persons and take the form of corporations or partnerships – Sociedad Civil (S.C.), Asociación Civil (A.C.) or Institución de Asistencia Privada (I.A.P.) – regulated by the civil code. As such, they not subject to income tax.

There are over 20,000 civil society organizations in Mexico, of which only 50% or so are legally recognized, according to data furnished by the Mexican Center for Philanthropy (CEMEFI). Based on the findings of a qualitative study on NGOs in Mexico City, on an operational level, these take three main types of organizational structure.

The first group comprises legally founded organizations with a formal structure and that are authorized to accept donations. These generally have efficient accounting and management systems that make it possible for them to divulge information on their plans and programs and file financial statements. They also tend to have a high degree of sophistication, since they account for the bulk of corporate donations and are transparent, both internally and externally. Their structure makes them eligible for federal funding, provided they are listed on the Federal Register of Civil Society Organizations (CLUNI). And in terms of governance, they tend to have solid management models, with decisions being taken jointly by a board of trustees or advisors.

Next are organizations that are legal entities, but that lack professionalization. These have an operating structure of sorts, but tend to be poorly managed, mainly because those responsible for the organization’s proper functioning often lack the knowledge to guarantee its optimum development, blocking the path to funding afforded by certain programs. Furthermore, a lack of assets often hinders the structural growth of organizations in this group.

Finally, the most worrying group are organizations formed by well-intentioned people with a common goal, but that are not legally recognized and, consequently, tend to lack management and accounting systems. Because they are not registered, such organizations are not required to provide information on their purpose. Even more alarming, because they are not required to render accounts, there is no way of knowing for certain how they raise their funds or if these are actually put to the cause donors -on whose good will they survive- are led to believe. And because they do not have to answer to any regulatory body, they are not subject to sanctions either.

To address the problem, several non-profit organizations in Mexico, like CEMEFI and the Board of Private Welfare Institutions (JIAP) -a decentralized agency of the Mexico City government-, run educational courses and workshops. This professionalization of the so-called third sector includes everything from advice on legal requirements for the founding of an NGO to help with administrative and accounting procedures, work programs, budgeting, and the filing of financial statements and tax returns to ensure transparency in the rendering of accounts, with emphasis being placed on the importance of electing a board of trustees or independent advisors to guarantee the organization’s sustainability.

According to sources at CEMEFI and JIAP, civil society organizations that are legal entities, have a solid organizational structure, are authorized to accept donations and are registered with CLUNI are more likely to achieve their goals and survive the test of time. And because they are subject to tighter controls and are required to render accounts to various bodies, they are less likely to divert funds to unauthorized causes.

Conclusion

Organizations lacking formal legal and management structures tend to disappear relatively quickly. This is because they depend mainly on the good will of donors and cannot accept donations from corporations, official organizations or government programs, since they are not authorized to do so and do not comply with applicable legal and administrative requirements. Regularizing such organizations is difficult, but not impossible with the help of the aforementioned training programs.

Equally important are the people chosen to manage the organization – preferably people with an educational background in keeping with the duties entrusted them by its governing body, to ensure obligations toward state and other private entities are duly complied with.

The management models many of these organizations currently employ have proven not to be the most recommendable. Notwithstanding, in the absence of a set of standardized regulations governing NGOs, campaigns promoting a culture of donation and educating civil society as to how to donate take on even greater weight, namely the importance of donating to official organizations as opposed to directly to an individual or cause. Donors need to be informed of their right to request financial information on the organization and details of the programs it implements with a view to achieving its stated goals. They also need to know they are entitled to request a tax-deductible receipt for the full amount of their donation. By the same token, organizations should be required to divulge publicly and on a regular basis the use donations are put to and it should be made mandatory for all organizations to publish an updated activities report at least once a year on their websites, which should be maintained in working order so the public can be sure they are efficient and are using their funds appropriately.

There is no magic formula that can overcome the limitations and solve the problems facing NGOs in terms of their management systems, rendering of accounts, structural growth and performance evaluation. Rather, NGOs in Mexico will become more professionalized to the extent civil society and the business sector demand they comply with increasingly stricter regulations.?

The success of companies’ strategies for finding, attracting and retaining clients and the ability to create a solid pillar of confidence in the market, which can lead to economic development, depends on an understanding of the basic concepts and principles of consumer protection.

Although the individual entrepreneur may have to pay a price to comply with consumer protection laws, in the aggregate, these laws generate social and economic benefits. The restrictions established in the Federal Consumer Protection Law (LFPC) coincide with the legally protected good pursued by other economic regulations, like those regarding the breakup of monopolies and unfair trade practices. The rights of the consumer should not be viewed as an impediment for the business, nor does complying with rules protecting these rights place the business at a disadvantage before the law.

In terms of jurisprudence, we find that in August 2005, the First Chamber of the Mexican Supreme Court of Justice presented the following thesis (registry number 177527): “… promoting and protecting the rights and welfare of the consumer, does not mean that the rights corresponding to merchants are excluded [...] and that therefore the law is discriminatory [...] furthermore, because [...] the law demands respect for the rights and obligations that stem from commercial relations, which lie with both consumers and merchants.”

Considered fairly, the legal framework protecting consumers should be something with which merchants should be spontaneously willing to comply. In other words, if the market is made up of rational agents, it is to be expected that all legal acts, both contractual and extra-contractual, conform to the consumer protection laws, because if all merchants respect them, they create conditions more favorable to competition. Businesses that do not have the capacity to compete in a market where those laws of public order are respected will be expelled, because consumers will no longer prefer them. Put differently, businesses that do not respect consumer protection laws cannot play on the same field as the others.

For example, let’s assume a company sells a product claiming that it has qualities that it does not have, and therefore deceives the consumer. Aside from the damage this might cause, economically or in any other way, such as health, this company competes in an economy by attracting a buyer away from other merchants that do not use false advertising to sell their products. Since money is a scarce resource, the consumer will not buy any other product with that money, because it has been spent, with no individual benefit for the consumer, or for the market, just for the dishonest business. Furthermore, it is likely that a collective damage was caused.

With regard to the possibility that the authorities may act to prevent or remediate collective damage, Judge Leonel Castillo González, in isolated thesis number 169985, in April 2008, noted that “articles 21 and 26 of the Federal Consumer Protection Law recognize the existence of a diffuse or collective interest of consumers, protected through collective or class actions, and they are legitimately represented, in the case of consumers, by the Federal Consumer Protection Agency.”

And if this were not enough, Judge Castillo González himself (thesis 169825) argued for the principle of civic collaboration, encouraging all of us to cooperate to promote and protect the rights and welfare of the consumer, and recognizing that the Federal Consumer Protection Law permits any party to report violations of that law to the consumer protection authorities, a principle that jurisprudence has extended to the authorities as well, as follows:

“This right and civic duty of social solidarity is applicable to the authorities, by overwhelming reason, because these have been created, regulated and, as they function for the undeniable purpose of contributing to the realization of the ends of the Rule of Law, initially organized under the principle of division of labor, but united by the indispensable need for total collaboration, for the pursuit of general common purposes.”

Accordingly, therefore, enforcing consumer protection laws is a matter of collective interest, and is not just a matter for consumers themselves, but for society at large. We all agree that the market must not tolerate antisocial practices like deceit, abusive clauses, failure to meet advertising promises, breach of contract or violation of guarantee, to name but a few.

It is useful to recall the criteria stated in a February 2006 isolated thesis (registry number 171064), by Judge Neófito López Ramos of the Third Collegiate Court of Civil Matters of the First Circuit, stating on behalf of the federal judicial branch:

“The rights protected by the Federal Consumer Protection Law are eminently social in nature, and their purpose is to prevent the economic inferiority of large groups of consumers from leading them to accept unfair commercial relations; it is therefore a body of law aimed at intervention and assistance of the most vulnerable classes of our society, on the premise of guaranteeing that public power will step in to protect the weakest economic groups and avoid injustice by applying to consumer relations some precepts of private law, which are based on the presumed equality of the parties to a transaction, a principle that does not exist between merchants and consumers, because the latter are group in need of protection.”

Even on an international level, there is a movement taking shape among international organizations, of which Mexico is a member, setting forth guidelines for effective protection of consumer rights. Among these is the recommendation that governments should strengthen and implement an energetic consumer protection policy according to the economic and social circumstances of each country, primarily to combat risks to health and safety (UN resolution 39/284).

In 1934, upon analyzing the constitutionality of the Bread Industry Regulation, the Second Chamber of the Supreme Court already perceived the existence of supra-individual interests that warranted protection and interpreted that the rights guaranteed by article 28 of the Mexican Constitution involve “protecting society and collective rights” and rather than impeding the intervention of the State, they actually require it.

Today, robust enforcement of federal consumer protection laws can only strengthen our Rule of Law, market confidence and economic activity, put an end to monopolies, and eliminate unfair trade practices. Consumers and merchants can play a fundamental role in building our economic system. It is definitely worth our while to respect consumers.?

By: Alex Horenstein and Alejandro Saltiel
Business School
ITAM

Diversification is one of the better known concepts in managing financial asset portfolios. According to the popular saying, diversify is “not to place all the eggs in the same basket”. The basic idea is that if an asset in a portfolio loses value, the investor has others to attenuate the impact of the loss. In other words, to diversify allows us to minimize the exposure of our portfolio against specific assets risk. (The only diversifiable risks are the specific risks. Risks common to all assets, the also called systematic risk, are not diversifiable). For example, on Monday, January 31, 2011 Intel informed that a failure in one of its new microchips will make it lose up to 300 million dollars (700 million according to some analysts). A portfolio that includes only Intel would have lost that day part of its value. Instead, a well diversified portfolio with other technological companies would not have to lose its capital. It could even increase its value since a loss for Intel may mean a gain for its competitors. In the following graph you can see the evolution of Intel and its more direct competitor, AMD, the day before, during and after this news was made known.

Graph 1

In Graph 1 one can clearly see how on the day Intel announced the failure mentioned herein above, its price was negatively affected and AMD obtained positive returns. Actually, the AMD value increased more than what Intel lost. Therefore, a portfolio with exposure to the microchip industry diversified in equal parts between both companies would have obtained positive returns, despite Intel’s negative news.

However, not all diversification ways are equally efficient nor do they have the same costs. If one would like to replicate the Standard & Poors 500 (S&P 500) Index that has the 500 companies listed, more capitalized in the United States, one should buy 500 shares and pay 500 individual commissions (one per each company included in the Index). Subsequently, in order to sell the portfolio one would have to pay 500 commissions to close each transaction. Luckily the technological and financial innovations offer a more economic alternative: the Exchange Traded Fund or ETF.

These are funds that try to copy the performance of a specific index or several stocks. They are valued as funds, but they are exchanged as common and ordinary stocks. In the S&P 500 case, one can directly buy the ETF called SPDR S&P 500 (ticker: SPY), at a cost similar to that of a common stock.

The variety of ETFs in the market is bib and it continues to grow. One can buy ETFs that replicate the value of the stock exchange indices of practically all countries. Likewise, there are ETFs that follow the value of previous metals, commodities, bonds, currencies and all assets that have a marketing value. This allows us to obtain well diversified portfolios at a very low cost.

In order to be well diversified, one can replicate not only one of the stock exchange indices of a given country; one can also have a portfolio that replicates the returns of a combination of all kinds of global assets. This allows investors to minimize their exposure to the specific (and avoidable) risks of the different assets.

To illustrate the concepts mentioned above, an optimum portfolio was made, defined as the portfolio that has the highest return possible for a specific risk level, the return, as the mean of the portfolio’s monthly returns in the period of time analyzed and its risk, such as variability (standard deviation) of that return in the same period of time. This portfolio uses standard techniques and date from July 2006 and July 2010. Four ETFs were selected to calculate the portfolio. The first one is GLD US Equity that exemplifies the return of gold as a precious metal. The second one is FBT US Equity, which replicates the return of the Arca Biotechnology Index of NYSE (New York Stock Exchange). The third one is IAH US Equity that allows the investor to be exposed to different internet architecture companies such as Apple, Dell, Cisco and IBM. Finally, the fourth ETF is BHH US Equity, formed by two companies engaged in the internet business between companies. The following rations were obtained after the optimization processes of each one of these four assets:

Graph 2

The portfolio obtained based on the ETFs mentioned have an average monthly return of 1.47% and a monthly risk of only 4.1%.

In Graph 3 a comparison is made between the portfolio risk and its return, versus the indices of countries that normally use this as a reference of a well diversified portfolio. As a comparison, portfolios were used that replicate the S&P 500 (A U.S. stock index normally used by portfolio managers to compare their investments with a benchmark), Dow Jones Industrial (stock Exchange index of the United States), Bovespa (Brazil’s stock Exchange index), IPC (Mexico’s stock Exchange index) and finally GLD, which replicates the evolution of the price of gold, one of the precious metals that has proven a significant return in recent years and that has received a great deal of attention in specialized media. In its vertical axis the graph shows the average monthly returns of the different portfolios and in the horizontal axis its risk measured as the portfolio’s monthly average variation. The only portfolio with more return than the optimum portfolio example is Bovespa; however, the risk assumed when buying this portfolio is more than twice that of the optimum portfolio. All the other portfolios show a smaller return and higher risk. It calls our attention that in a 500 stock portfolio such as the S&P 500 there is higher risk and lower returns than one of only 4 ETFs like the one proposed. It is also noteworthy to see that many of the industry portfolio consultants and managers compare the returns obtained in their portfolios against the returns of indices that are clearly not optimized, such as could be the S&P 500 or the Dow Jones Industrial.

Graph 3

The problem of portfolios that replicate countries’ indices is that they do not diversify globally. For example, you can buy an ETF called iShares MSCI Emerging Index Fund (ticker:EEM) that replicates the return of a portfolio (weighted by the capitalization value) of countries of emerging markets (China, India, Brazil, Mexico, etc.). This ETF is going to be less sensitive to changes in the domestic policies, compared to the sensitivity of a portfolio that for example, replicates the return of one of those countries.

Definitively, the new advances and progress in financial issues allow us to obtain portfolios, at a low cost, with a degree of diversification that previously could only be created by paying exorbitant commissions. A good long term investment strategy is to buy a globally well diversified portfolio, and this can be achieved by using a couple of ETF and at a very low cost. Historical data shows that an investment of this kind is profitable and hardly beaten by traditional portfolio investments, even by finance professionals. In recent years diversification has become significantly simplified and it is within reach of all investors, regardless of their degree of sophistication. This article proves that even popular sayings are obsolete in view of the advances achieved by new technologies. In order to have a good diversification it is not longer enough to place the eggs in a different basket, one also has to make sure that they come from different hens.?

By: Cuauhtémoc Altamirano, Federico Hernández and Hugo García
KPMG Cárdenas Dosal, S.C.

Capital Development Securities, (CKDs as are known in Mexico) are a type of trust security designed to finance long-term public works, infrastructure, realty and technological projects. Such is their potential that it is hoped they will help reactivate the Mexican economy and enable pension funds to offer savers more for their money.

Although they are the “new kid on the block”, CKDs are already shaping up as an interesting alternative for the financing of large infrastructure, realty and commercial projects in Mexico. To date, the Mexican Stock Exchange (BMV) has seen more than 12 CDK placements for over 30 billion pesos and there are more in the pipeline. The main challenge will be to spark the interest of accredited investors, namely Specialized Retirement Investment Funds (SIEFORE) and their corresponding Administrators (AFORE), which have an estimated 1.4 billion pesos available for investment in these instruments.

CKDs are negotiable securities issued by a trust, to which a company transfers assets that generate variable returns. An excellent opportunity for institutional investors, Mexico is just one of the countries that has embraced this new investment mechanism, along with Australia and Canada, where they are known as Income Trusts. But it wasn’t until 2009 that this was possible, when reforms were introduced making it legal for Mexico’s SIEFORE to invest in private enterprises and projects. CKDs are designed to finance medium to large projects over the long-term and, as such, are attractive to companies and projects that require long-term investment, as well as institutional investors on the hunt for risk-controlled opportunities that offer competitive returns. The SIEFORE fall into this category, and, to a lesser extent, insurance and bonding companies, which can also purchase CKDs, as well as investment companies, private pension funds and accredited individual investors.

Unlike common stock, CKDs have a term, generally ten, 20 or 30 years, or as stipulated in the placement prospectus, while stocks represent a company’s equity indefinitely or until such time as the company is wound up. In both cases, investors are equity partners, but under the CKD model, they intervene as trustees and sit on management and audit committees. Once the term expires, the trust management must dispose of the assets and divide the proceeds among investors.

CKDs are also different to debt securities. In a conventional bond placement, the issuer agrees to pay a known and previously negotiated rate of interest, whereas CKDs do not secure liabilities, but represent part of the company’s equity and assets – maybe an airport or a highway concession. In this respect, they are more akin to common stock. As equity partners, investors are entitled to a percentage of profits and may participate in the organization’s governing bodies. In the case of CKDs, profits are linked to the business’ success, i.e. investors will only see a return if sales are good or if the assets the company owns or acquires appreciate. They may even make money on the sale of other, non-priority assets.

Long-term Investments

Are there long-term investments that offer competitive returns for both SIEFORE and other institutional investors? Although they are relatively new, CKDs could well be the solution to the complex dilemma of how to finance medium- and long-term projects at an acceptable risk level and still hope to earn attractive returns for, say, the thousands of savers affiliated to one of the country’s pension fund administrators.

In the short time they have been around, CKDs have sparked considerable interest on the market and among investors, including financial institutions and experts with the necessary experience to trade in them. To date, the Australian bank Macquarie, the Mexican construction company ICA in partnership with Goldman Sachs Infrastructure, the Nexxus, WAMEX and Atlas Discovery funds, Prudential Real Estate Investors, Promecap and HSBC-Navix have all made CKD placements with a view to securing financing.

As mentioned previously, CKDs are basically designed to finance infrastructure, yet they can also help finance property developments, technological, private equity and mining projects.

Prospectuses and ticker symbols for each placement are published on the website of the Mexican Stock Exchange (www.bmv.com) along with information on their purpose, term and type of management.

CKD Placements in Mexico

Since 2009, the year in which legal conditions for the issuing of CKDs were created, 12 placements have been made, the proceeds of which have been used to finance infrastructure, equity capital and property development projects and, to a lesser degree, financial entities. The most talked-about of these was the placement made by Red de Carreteras de Occidente (RCO), a subsidiary of ICA, in which Goldman Sachs Infrastructure participated as a financial partner. The issue raised 6.55 billion pesos (which was used to refinance short-term liabilities). Placements have also been made by the Australian bank Macquarie (3.4 billion pesos), HSBC-Navix (4 billion pesos) and AMB (3.3 billion pesos), while participating Afores included Banamex, Coppel, HSBC, Inbursa, ING, Invercap, Metlife, PensionISSSTE and Profuturo.

Opportunities for Issuers and Investors

Given that CKDs target large investors, it should come as no surprise they haven’t garnered much media attention. Yet we are dealing with a novel investment tool that could turn out to be instrumental in promoting development in many sectors of the Mexican economy.

There can be no denying the lack of long-term investment options in Mexico. These presently include Treasury Certificates (CETES) and ten-year Pemex bonds, which have minimum or very low risk attached, but pay out modest interest. This is hardly motivational for the institutional investor segment, particularly SIEFORE, which demand returns on a par with the expectations of the country’s future retirees and which, pursuant to the Retirement Savings System Law, may invest only a portion of their assets in higher-risk, variable income bonds.

By the same token, restrictions on long-term financing affect organizations engaged in large-scale projects that take time to mature and that won’t generate profits for several years. This is precisely where CKDs come in. Designed to finance long-term projects with the help of well-identified investors whose resources and investment needs coincide with their unique features, CKDs are emerging as a great investment opportunity, as the Afores that have already invested in placements on the Mexican Stock Exchange can attest to.

AFORE as Future CKD Investors

Although Mexico’s AFORE manage a substantial amount of assets, they are no match for the value of those handled by pension funds in similar countries. Likewise, contrary to trends in other countries, in Mexico the financing provided by pension funds like the AFORE is relatively low compared to bank financing. However, in the medium term, AFORE financing is expected to exceed financing extended by Mexican banks. We believe that, while AFORE currently invest mainly in government securities, with CKDs accounting for no more than 3% of their total investments, the strong growth projected for pension funds will come hand-in-hand with increased investment in this new financial phenomenon.

CKDs have the potential to balance out companies’ financial needs (including a long-term perspective) and the interests of large institutional investors, namely AFORE, which need to invest their assets to the benefit of the workers who contribute to them.

Boasting features that set them apart from ordinary shares, debt securities and other investment instruments, CKDs have awakened market interest, as evidenced by the fact that the first five placements in Mexico raised a total of 16 billion pesos in 2009. By 2010, this figure had surpassed 17 billion, with another 10 placements in process in 2011.

As this instrument gains popularity, it is vital we understand the associated risks and challenges and establish regulations and guidelines to protect both investors and issuers.?

Table 1: CKDs, Issuances and Prospective Placements

By: Polux Díaz
Director of the Program Master’s Degree in Finance, ITAM

When a Company wishes to grow and does not have the necessary means to make it happen, it should resort to the capital markets. You can be obtain funds there in two ways: with debt by obtaining a bank credit or by issuing some kind of bond in the market and the second is by issuing stock. A severe problem found when using this last method is the few means investors may have to acquire shares of the Company in the Mexican market, but this does not mean that the Company is in bad conditions or that its shares are not attractive, it is simply due to the fact that the number of investors that can acquire shares in a market like the Mexican is low, so they may not be willing to acquire more shares either because their funds are invested or simply because they may think is not attractive enough to acquire them.

What to do in such a case? You can always decide to try to use another security that is not a debt instrument. However, such a decision could get a company into trouble because it forces the market to accept something it does not want. There is another alternative quite unexplored by Mexican companies: to issue stock in a market that is not the “Mexican” exchange; a market that is full of different kinds of investors and where they are hungry for different instruments (depending upon the risk-return profile they may offer); for example the U.S.A. market.

What is an ADR?

The right way for Mexican companies to be listed in the New York Stock Exchange is with American Depositary Receipts (ADR). The way to do it is to contract with a “sponsor” bank where the stocks issued are deposited and in exchange the bank issues the ADRs. Since often the Mexican stock prices when converted to U.S. Dollars are very low as compared to market prices, the ADRs have an aggregate rate that can be 10 to 1. This means that each ADR issued represents 10 shares. Thus, the price is more appropriate for the market. There are four different kinds of ADRs that can be issued in the United States; Table 1 shows its main characteristics.

Table 1

Characteristics of the ADRs traded in the United States.

You can appreciate that both Level II and also Level III refer to public ADRs, while Level I and 144ª refer to private issuances.

What Are The Advantages Companies Have When They Use ADRs?

There has been a great deal of debate as to whether the use of ADRs has an advantage both for companies that use them and also for the stock market in general. Companies ask themselves the following question: Why should I invest up to US$2,000,000 to issue stock in another country? With all the follow-up given to public companies by financial institutions in the United States, how much more will I have to spend to generate information? Is there really a difference in issuing in the United States, asides from raising capital?

Apparently, there are several benefits associated to the issuance of capital when using ADRs, and although the literature is not definite on its conclusions, it does leave the door open for Mexican companies to assess the use of this instrument not only as another way to obtain funds, but also because of the potential associated benefits.

Perhaps the most important and also the most controversial benefit is the fact that apparently, when companies use ADRs, their value increases. Doidge, Karolyi and Stulz (2004), find that the q of Tobin (Tobin-q), a generally accepted measure as representative of the creation of value is 16.5% higher for companies that are listed in other markets as compared to those that have presence only in their local market. However, this is debatable since Miller (1999) finds that this effect exists, but it greatly depends on the place selected to issue ADRs (United States vs Europe), the way it is done (if it uses or not a public level) and finally the local market where the issuing Company is located. For Miller, only companies that issue in the NYSE and do it using Level III ADRs (raise new capital), shall be the ones that will increase their value.

This improvement is not only in the perception of value, it is apparently also in the stock price. And the big question is Why?. What makes these companies have better prices than similar companies that do not have ADRs? The answer seems to be very simple: How these companies are perceived, improves significantly when ADRs are used in other markets. Since the information disclosure rules are (generally) much more strict in the United States than in other countries such as México, when the firms issue Level II and Level III ADRs, the companies bind themselves to disclose much more information than their local markets demand they do. Since this has been done voluntarily, the market interprets this as a good signal and rewards them by acquiring their shares. Consequently, they are quoted at a higher price than similar companies that do not have ADRs.

And this is one of the advantages that impacts not only the company that issues the ADRs but also the entire market. The more companies issue ADRs, in the United States and in other developed markets, the more information that will be present in the market, and in general it will be more transparent. Consequently, new companies will want to issue in the local market, etc. One can appreciate how a virtuous circle has been created and it has excellent repercussions in the country.

One of the more interesting effects seen with the ADRs is the one related to liquidity and volatility in the local market. Intuitively, one could think that the ADRs provoke a reduction in the liquidity and an increase in volatility. This is because when you have two markets where the same good is quoted, if one wishes to sell the position it has in a stock and in the local market the prices are high, it can always go to the United States and sell the equivalent in ADRs, and this causes a reduction in liquidity. Regarding volatility, since the stocks are in the U.S. where they are subject to many external shocks, some of them could be “contagious” to the stocks in the local market and this causes an increase in volatility. It is interesting to see that both effects seem to be mitigated by the competition between the two markets, and thus the spread between the purchase price and the selling price is smaller; therefore, the result is an increase in liquidity and a decrease in volatility (Domowitz, 1998).

There are many intrinsic benefits in issuing ADRs. One of them is that when the company needs money and since there is a great deal of information about it, it will be easier for the market to correctly value the instruments that it will issue, and the result of this is that its capital cost decreases slightly (Doidge, Karolyi y Stulz, 2004). But the true gain comes from the fact that the capital markets are open when the firm needs them, and it will not have to pay an over-cost that companies that do not have ADRs, have faced.

Everything Seems Perfect, but …

As can be seen, there are many advantages to the issuance of ADRs, specially when they are Level II and Level III. The literature supports this kind of instruments and apparently there are many gains for the companies and for the market in general. Therefore companies should issue ADRs, frequently without even needing the capital but rather due to all the additional benefits they may have. But, don’t go so fast! Are these really only gains? There is no evidence against them

Fernandes and Ferreira (2008) made an investigation of companies that have their equity listed in several markets and their conclusions are interesting. When the emerging economies are analyzed, they have found that the advantages mentioned in this article are true, but apparently this is true provided the companies come from more developed markets. When emerging economies are analyzed, apparently the advantages are not seen and thus the result is entirely the opposite. They say that the market’s “informative environment” (everything that leads to analyze the financial information: the analysts, the rating agencies and even the investors themselves) is deteriorated because those “educated” investors (or institutions) migrate to markets where ADRs are traded, and this causes that investors that have less analysis capacity, stay in local markets. This, instead of improving the valuations and perceptions of the company, causes a completely opposite effect. All that has been mentioned above regarding the volatility, liquidity and valuation is reverted, given the fact that the market participants do not have the capacity to adjust their estimates because the company’s capital is being traded in several markets. The result is smaller valuations, capital cost increases in capital and in the operating costs of the Company.

Conclusions

The issuance of ADRs in the American market represents a formal alternative for companies to obtain funds. It can give them a solution they did not have, access to cheaper capital and at the end to have secondary repercussions that impact their cost of capital and the general perception in the market. But it seems that this only happens if the Mexican financial market improves the information efficiency terms and the number of participants of those companies that are listed in it and also of the investors that participate in it.?

References

Doidge, Craig ,Karolyi, A., Stulz, R. (2004). “Why are foreign firms listed in the U.S. worth more?”. Journal of Financial Economics 71, 205-238.

Domowitz, I., Glen, J., Madhavan, A. (1998). “International Cross Listing and Order Flow Migration: Evidence from an Emerging Market”. Journal of Finance 53 (6), 2001–2027.

Fernandes, Nuno, Ferreira, M. (2008). “Does International Cross-Listing Improve the Information Environment”. Journal of Financial Economics 88, 216-244.

Miller, Darius. (1999). “The market reaction to international cross-listings: evidence from depositary receipts”. Journal of Financial Economics 51, 103-123

Pagano, Marco, Roell, A., Zechner, J. (2002). “The geography of equity listing: why do companies list abroad?” Journal of Finance 57 (6), 2651-2694.

By: Renata Herrerías
Business School, ITAM

No company is immune to liquidity risks. There may be businesses that are “more liquid” than others but the little availability or pressure to obtain resources to face short and medium term commitments is one of the determining factors for the long term feasibility for any and all businesses.

If an organization tries to grant credits by using resources from third parties, the liquidity issue is still more critical. In general terms it will be highly leveraged and it is precisely this leverage that allows businesses to do business. In general terms, this is the business of banks and intermediaries.

Since General Electric Capital Corp., appeared in the 30s in the United States and the 90s in Mexico, an alternate system to the banking system was developed and was engaged only in granting consumer or mortgage credits. This parallel system formed by financial companies not financed by traditional deposits, contributed to give access to credit to a large number of families and companies that traditional Banks did not serve. At times when economies grew and banks did not fully meet the entire demand for credits – especially in Mexico after the 1995 crisis – the financial companies started to cover those spaces left by banks. In general, these were lightly regulated intermediaries, financed with loans obtained from other financial institutions, loans from their Industrial segment (parent company) or from the financial markets.

It seems that only 15 years after they appeared in the Mexican financial system, the Sociedades Financieras de Objeto Limitado (Non-Bank Financial companies, or SOFOLES as per initials in Spanish) are condemned to extinction. Of the almost 60 SOFOLES in 2005 -when there were 29 commercial banks – only 20 survive today. Either because they were acquired by a financial group or because they became a Sociedad Financiera de Objeto Múltiple (Multiple purpose Financial Associations or SOFOMES as per initials in Spanish) or because they went bankrupt, the specialized financial intermediaries have gradually disappeared from the Mexican market.

In October 2007, Paul A. McCulley, in his presentation at the New Frontiers Conference in Institutional Asset Management explained that liquidity, more than a monetary policy issue is a phenomenon related to the risk appetite of lenders. For McCulley this liquidity is a mental state about risk. It is the result of the appetite of investors to assume risk, and of the savers’ appetite to help leverage the investors that want to take it. Because the government financial companies are not covered by deposit insurance as traditional banks, the financial companies become much more vulnerable to the movements in the appetite for the investors’ risk and therefore to changes in liquidity.

Can the disappearing process of the SOFOLES be explained by the changes in the risk appetite? Or rather what happened to the Mexican SOFOLES is only a reconfiguration of the market in which the commercial factors are the only ones that explain the contraction of the sector?

Up until before 1993, the mortgage and consumer credit offer in Mexico was limited only to banks. As part of the agreement to enter the North America Free Trade Agreement, the Mexican government was asked to promote the creation of specialized financial intermediaries so that there would be more financing alternatives. The idea was to allow the existence of specialized financial intermediaries similar to those that exist both in the United States and Canada (Non-Bank Banks). Besides specializing in some type of credit, an important aspect of this kind of institutions is that the resources to grant credits do not come from the savings of the population.

As a result of the severe banking crisis of 1994-1995 and the consequent withdrawal of banks from the credit market, SOFOLES experienced a boom as they covered the spaces that traditional banks left empty. The SOFOLES grew exponentially even in deceleration periods, at rates way higher than the growth of the economy (Figure 1). The end of the 90s and the first half of the 2000 decade marked the best period for this sector.

During the second half of the 2000 decade, the market started to reshape. First, traditional banks intensively returned to the credit market and their objective was to recover their participation in it, hence the SOFOLES became their natural target. Several banks acquired SOFOLES consolidated in their specific niche. An example of this is BBVA Bancomer and Hipotecaria Nacional or Ixe and Fincasa.

On the other hand, given the market conditions and in trying to deregulate and contribute to the diversification of their assets, in July 2006 the creation of SOFOMES was approved. This is how starting at the end of 2006 the number of SOFOLES independent from banks or financial groups decreased little by little, and this left the space to the SOFOMES or to the financing companies under the tutorship of a large financial group. Even so the loans channeled through the non-banking financial companies represented almost 3% of GDP, as compared to 1.1% they managed in 2000.

Figure 1: Total Loan-Portfolio and Annual % Growth in Total Loan Portfolio, SOFOLES (1997-2005).

Fuente: Elaboración propia con datos del Banco de México

Funding

Before 2000, the main funding sources for the SOFOLES were banks, government support programs. As of 2000, the SOFOLES started to have access to the financial markets that represented up to 24% of the liabilities obtained in 2006. There was a great appetite in the market for profitable investments. In a growing sector and with favorable perspectives in every way, the loans from other financial intermediaries decreased little by little and representing less than 20% in 2003.

From the analysis of the composition of the liabilities one can see how the real estate SOFOLES controlled the industry. With the government housing programs of the previous administration, the resources obtained from government programs represented almost 60% of the funding obtained by the SOFOLES in 2003 (Figure 2).

The situation changed radically between 2007 and 2008. Asides from the transformation of SOFOLES into SOFOMES to operate in an unregulated scheme, the contraction of the financial markets and poor performance of some institutions left the surviving SOFOLES without access to resources; 76% of the resources to operate the few institutions still alive had come from banks and today only 15% comes from the financial market. Financing from the government and other financial intermediaries only represents 9% of the funding.

Figure 2. SOFOLES, balance and % composition of funding sources, millions of MXN pesos (1997-2010) (Loans from financial intermediaries, government funding and public debt)

Source: Prepared with data obtained from Banco de México

Risk

During the first seven years of the 2000 decade the markets clearly had high appetite for risk, there were liquid resources channeled to more attractive investments, not necessarily because of their optimum ratio between risk and return, but simply because they offered higher returns. In general, investors risk aversion decreased and therefore appetite for risk increased.

More liquid markets, better interest rate conditions, a growing economy and a bank sector that did not service the credit market explain why the SOFOLES grew exponentially. However, as history has always proven, the accelerated growth of credit markets almost always is accompanied by a decrease in the quality of the debtors. The history of 1994 was repeated by the SOFOLES, although it was not a problem of the same dimensions and consequences, the bankruptcy of companies such as Metrofinanciera or the solvency problems of Hipotecaria Su Casita are clear proof of how fragile the sector was when liquidity contracted.

Risk was perceived in several areas: deterioration of the assets, lack of liquidity, decrease in the intermediation margin and decrease in capitalization ratios. For example, Figure 3 shows the sudden drop of the net interest income and the net interest margin. Both are explained by the deterioration of the assets that as they became non-performing they stopped accumulating financial income, and the increasing interest rates paid for liabilities from bank lending (figure 4).

The liquidity problem became more acute when the portfolio deteriorated. The delinquency index of SOFOLES, from being at a 2% optimum level at the closing of 2010 had higher than 12% levels (Figure 5). If the client does not pay, the intermediary in turn cannot comply with its commitments and specially when it does not have government guarantees or deposits insurance as banks have.

Figure 3. Net Income (millions of MXN pesos) and Net Interest Margin, SOFOLES (1997-2010)

Source: Prepared with data obtained from Banco de México.

Figure 4. SOFOLES, funding cost, measured as the ratio of interest paid over total liabilities (1997-2010)

Source: Prepared with data obtained from Banco de México

Figure 5. Delinquency Index, Non-Performing Portfolio / Total Portfolio, SOFOLES (1997-2010)

Source: Prepared with data obtained from Banco de México

Leverage, Deregulation and Crisis; the Perfect Storm?

This is a known history. Between 2007 and 2008 the biggest financial crisis happened in the United States since 1929. The bubble of real estate prices burst and collapsed the value of the structured instruments that financed those transactions. The perfect storm of the financial markets materialized: the riskiest debtors went into default, the collateral value of the credit transactions collapsed and therefore the structured instruments that financed the subprime mortgages entirely lost their value. All of this broke not only investment banks, but also complete economies like the Icelandic. Of course Mexico was not an exception and it also suffered from the contraction of the generalized liquidity contraction of the financial markets. Capitals returned to risk free investments such as the United States Treasury Bonds.

Regarding the less regulated-high levered parallel financial system, McCulley explains that the pressure to reduce leverage, increase the collateral value and the refusal to refinance transactions by the investors, transformed an unlimited liquidity situation into a sudden contraction of the resources to refinance transactions. If the main financing sources of SOFOLES were banks and the financial markets, when funding was reduced in general, both banks as well as investors channeled their funds to less risky, less leveraged and with higher liquidity entities. The appetite for risk dropped and the markets were no longer willing to support leverage and the growing risk. Intermediaries such as SOFOLES could not sell their assets fast enough to meet the growing risk aversion of the investors.

Conclusions

McCulley states that liquidity is a state of mind of investors. The development of the specialized financial intermediaries industry happened at a market crossroads in which the traditional channels closed and there was a great deal of liquidity. Both conditions no longer existed and the risk appetite had dropped significantly.?Despite the fact that the credit market in Mexico is very big and continues without being completely serviced by banks, the recovery of the sector shall be slow and difficult. It appears that access to stable long term financing sources and at a reasonable price shall be the factor that will determine if the sector will survive or disappear.?

References

McCulley P.A., “The liquidity Conundrum”, New Frontiers in Institutional Asset Management Conference. Sacramento California, Oct. 2007.

Comisión Nacional Bancaria y de Valores (National Banking and Securities Commission), “Boletín estadístico, Sociedades Financieras de Objeto Limitado” (Statistics Bulletin, SOFOLES). Several issues.

By: Irina Nikolaeva and Antonio Quesada
PwC

Part of the discourse in human capital management is that employees are the most important part for an organization to be successful. But, sometimes, this discourse lacks empirical evidence.

Nevertheless, PwC recently made a world level study that revealed that in those countries where a significant investment has been made in human resources, the Gross Domestic Product (GDP) per hour worked has also experienced a big increase. In that sense, the research states that emerging countries such as China, the Czech Republic, Estonia, India, Poland or Brazil, amongst other, show a 10% GDP growth per hour worked, and underlying that fact is a strong capital investment in human resources. Actually the Brazilian case is at the forefront as a result of its investment in technology and research.

Which are the issues shared by the most successful countries in this area? Asides from good regulations, they show a government’s effort focused on improving education in schools, universities and institutes. In parallel, the private sector has also increased the resources destined to the training and gives more emphasis to incentivize the mobility of talent within their organization. The work carried out by PwC (called Human Resources Trend: Global Vision) bases its figures on data from the Total Economy Database. The study was made amongst more than 10 thousand companies in 40 countries and it shows the trends in how human capital is managed in those markets. These points of view were also compared with the main macroeconomic indicators or organizations that are the leaders and develop the participation of their personnel. One of the conclusions was that the implementation of these new management tools leads companies to curve their costs.

PwC implements every year the CEOs global survey. During the crisis’ years at least 80% of them in each region of the world started to reduce costs and more than half stated that they could resort to reducing headcount. Companies settled in North America and Western Europe took more drastic measures; 69% of the companies in the United States reduced their personnel, while in the United Kingdom 63% of the companies adopted the same measure. The reduction of personnel was the remedy more frequently used in the automotive industry with 80%, the manufacturing industry with 68%, the communication media and the entertainment sector with 71%. This short term solution may have long term negative effects in the recovery impact and competitiveness of the business in future years.

The last CEOs survey highlights the three big failures of human capital as a consequence of the recession:

• The compensation models are obsolete and do not coincide with their objectives in many of their parts. In addition, the heavy burden of the pension liabilities and of medical expenses paralyzes many successful organizations in the United States and in Europe.
• The CEOs were incapable of quickly relocating their talent when the crisis impacted them. On the one hand this caused large scale layoffs to save money and on the other hand it vacated crucial talent positions. The organizations have to find the ways and means to move their people where they are more needed. Those that resorted to a drastic reduction of their staff are facing today a costly and growing rehiring and professional readaptation exercise.
• Many organizations lack the key skills that are necessary to operate and compete with the new environment such as: the awareness of higher risks, adaptability to the market, change the management capacity and respond to the new clients’ demands, etc. 76% of the CEO’s plans want to increase the budget to train and educate their talents.

Listen

Reading Phonetically

It is also stated that the organizations should highlight the new techniques to find and select their employees by considering that there is a shortage of talent, and at the same time, there is tremendous competition after it. “Companies should not be closed to people that do not have the experience in the industry in which they work, but rather they should analyze their skills”, states the study.

Motivation

A way to retain talent is through motivation, which in turn is a basic component to increase productivity. This leads to the need to generate effective human resources policies that include incentives (for example and amongst other, career development policies, training, and quality of life at the work place) that at the end of the day increase personnel skills.

PwC states that this is also an efficient way to detect the best talent, so that companies may start to consider the potential successors to specific positions. According to the report, this has been a differentiating issue in the countries that have been more successful on this subject.

innovating Cultures

Another variable is innovation. The report states that to promote an innovating corporate culture generates an increase in the competitiveness indices. However, this is an issue that developing countries still do not stress, as can be deducted from the fact that between 2002 and 2007 investment in research and development made by companies in developed countries increased 45%, while in the same period the developing countries had a 7.6% increase.

On the other hand, based on the global experience obtained in the study that states that companies that use subcontracting should move towards a new approach that leads to a higher cost savings. This focus consists in the relationship with the suppliers moving towards a more collaborative business model, with less complex and more flexible contracts that result in a higher added value through specialization. “Future subcontracting should be more focused on improving the products and increasing productivity, before trying to only reduce costs” emphasizes the report.

Innovate Instead of Laying off

This study also considers the experiences caused by the financial crisis on the management of human resources. On this issue, it states that the companies opted to reduce costs by making drastic personnel reductions. However, this measure implied a major expense for companies and subsequently it led to hiring other professionals who did not satisfactorily meet the work requirements.

What the companies can do is to evaluate the productivity and profitability costs in their various functions comparing them with similar teams in the market. As a result, the organizations can be capable of identifying low yield persons, and providing a business model to relocate the persons that require it the most. This allows the more skilled persons to grow despite the global stagnation or personnel reduction throughout the entire organization.

The leading organizations that use the key metrics, such as the performance metrics, that help monitor the differences amongst colleagues, production centers of one group versus another, subsidiaries, or business units, etc. These metrics are also used to compare one organization with its competitors and this helps establish the points of reference.

Therefore, the recommendation is to apply measures which final result is equivalent to the saving expected by layoffs, amongst other. For example: freeze salaries, offer sabbatical years, adjust the expense policies of employees and favor internal recruiting instead of external talent, amongst other.

It would be advisable to look at these concepts because Mexico has recently reported that it fell one point more in the World Competitiveness Index prepared by the Business School of Switzerland (IMF) as it went to place 47 from the 46th.

In addition, the recession has deeply affected employers as well as employees. World productivity has dropped after its increase in 2008. On the other hand, despite the low interest rates, in all environments, employees should not lose from sight the importance of labor agreements and the planning of succession.

Employers should take measures today to manage labor agreements in a reasonable period of time and thus avoid economic conflicts and contain costs. Those that do it shall be in a better position to benefit from an economic recovery.?

References

Phelps, R. (2010), Tendencias en Recursos Humanos (Trends in Human Resources): Visión Global, PwC, 2010, p. 2, 4.

Quesada, José Antonio (2008), El Comportamiento Humano en las Finanzas. IMEF