Generating Investment Ideas: Interview with Entegra’s Jim Butcher (Part 2)

In part one of my interview with Jim Butcher about generating investment ideas, the former head of Morgan Stanley’s Strategic Engagement Group and current CEO of boutique consultancy Entegra Partners, we talked about how scenario planning is one of the most potent tools for dealing with an uncertain world. Furthermore, we talked about how results from scenario planning often trump those of risk management. Here then, is part two of my interview with Jim Butcher.

CFA Institute: It sounds like scenario planning is much more than just risk management, but is also about opportunities.

Jim Butcher: Yes, as you know, the flip side of many risks are opportunities — and even more so for financial services and investing, since you can often hedge on both sides of a possible outcome. While being very conservative and hoarding cash is one rational response to the economic uncertainties today, it is also not being very creative and trying to see new opportunities.

Much of what we have covered so far is well known about scenario planning, but one of the reasons I think that you are such a worthwhile source is your ability to simultaneously discover and describe hidden benefits of the work you do. So I wonder if there are some other benefits you have discovered from engaging in scenario planning that you would like to share.

I’ve mentioned some already, but others are:

• Challenging the status quo. In many industries and often in investment management, it is easy to be swallowed whole by current assumptions and conventional thinking. It’s like the Einstein quote that you can’t solve a problem with the same thinking that created it. Most of our mental models and thinking patterns, trust me, are very difficult to change!
• Only the prepared mind can respond in time. Going back to my Shell story and OPEC emerging as an oil cartel — other oil companies didn’t have a framework to understand what was happening. Depending on the industry and situation, this can allow and open up tremendous windows of opportunity. This also leads to new pattern recognition skills, which are sorely lacking for many executives.
• Pausing long enough to have an in-depth conversation about the business or investing future. Too much of the time in companies, planning is an annual “rain dance,” in which the past year’s assumptions are tweaked for next year’s forecast. No real conversations take place. Scenario project after project has suggested to me that just getting the right decision makers in a room to have, what I simply call, a “strategic conversation” about the business and the future is so, so useful. When there is so much economic and investing uncertainty out there today, what’s a day or two worth to get a better handle on how to recalibrate? From this work, more alignment and clear marching orders can be created across an organization’s teams, including getting folks excited about the next year and capital allocation or investing actions.
• Identifying key signals or key moments when critical things change. This is especially important when lead times to change assets, invest, or hedge are limiting factors. Today, I am spending as much or more time helping my clients with tracking key signals and deciding on actions as creating scenarios.
• Identifying and assessing of options whose window of opportunity is often fleeting. In today’s globally connected world where more trading depends on milliseconds and even large businesses are nimble, many options will happen — and disappear — in shorter windows of time.
• Mental models and leadership. Scenario planning helps business leaders and investment managers to break free of traditional mental models to make their minds more flexible, often permanently. This helps make leaders more adept in recognizing changes and responding to them better. Again, my quote earlier of a changed “center of perception” has been many executives’ experience with this approach.
• Right answer, but wrong timing. Often scenario planning will reveal a problem that triggers a prepared response. It is often the case that the problem that created the solution never materializes, but a problem similar to it does arise and the solution is then easily implemented. During the run-up to Y2K (remember, the nonevent!), MS did a scenario exercise and came up with a risk concern that banks, say like a Bank of New York, wouldn’t be able to clear trades if computers goofed up. So, as we know, Y2K came and went with a whimper, but then 9/11 sadly happened, and guess what? Banks weren’t able to clear trades. Having thought about this the previous year, MS knew what to do and a crisis was averted.

I especially appreciate that last point, because often scenario analysis is deemed to have failed because the event, or events, it predicted don’t happen. Yet, a response might be dead on for a similar, but entirely different reason. I especially found this to be true in my money management career. A financial modeling solution was developed for one company but turned out to be more usefully applied to another company.

It’s the value of the anticipatory thinking process and being able to be flexible to rethink or remember what to do in a similar situation.

Clearly scenario planning is a very involved process. But could you give our readers some sense of what you feel is the path of least resistance to crafting useful scenario plans?

Good question. For the early years of this work, there was a standard scenario planning process that took three to six months with two or more workshops. Given experience, experimentation, and client pressures over 20 years, I’ve tried to be more and more flexible, do it in shorter time, and still get a great result. Depending on the issue, I can do a good effort now in one to three months that yields important results and insights. I’ve also been experimenting with a much faster, shorter scenario “thinking” versus planning approach that is proving to be valuable in simply getting the key issues out on the table and giving useful, if not profound, insights quickly.

To find a good path to do this in your organization, find a champion internally who’s interested in trying this approach or an issue that is very important to the next year or to the success of the company. Inform the right folks internally how scenario planning might be useful for the issue you or your company is facing. And, not to be self-promoting, get good help to craft a great scenario effort. I’m sorry to say this, but after my experiences and teaching this to thousands of students, it’s simply not easy to hit a home run in one’s first efforts.

Jim, thanks very much for your insights about scenario planning. I hope that our readers are able to apply your wisdom to their own unique situations.

Thanks for the conversation. Over the last year of doing this work, I can honestly say that I’ve never seen as many uncertainties as we have in today’s world. I hope this approach can be useful for CFA Institute members, since we need a lot more optimism and good returns going forward.

Originally published on CFA Institute’s  Enterprising Investor.