Even the Odds

Sensible Risk-Taking in Business, Investing, and Life

Karen Firestone

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781351861861
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

In Even the Odds, Karen Firestone explains how risk assessment plays a prominent role in all aspects of life. We may all define risk, and our tolerance for it, somewhat differently, but we might all agree it plays a pivotal role in guiding us toward an optimal outcome. As a long-time investment advisor, Firestone has grown accustomed to interpreting risk on a daily basis. She has developed four core tenets of risk-taking we can all apply to anticipating, evaluating, and responding to the risks we face in our business, investing, and personal lives. These tenets are right-sizing; right-timing; relying on skill, knowledge, and experience; and staying skeptical about numbers, promises, and forecasts. Firestone's approach is both practical and accessible to individuals who are making important decisions, such as embarking on new career or life changes, starting or running an enterprise, making a sizable investment, or deciding how to balance across a full portfolio of assets. The book is rich with anecdotes and examples of how many prominent leaders in their fields encountered and dealt with risk along the way. Firestone also shares her own successes and failures, in particular when she decided to risk it all--a fabulous career managing billions of dollars at a premium investment company, her reputation, and the security at home that comes with a strong and stable job--to go out on her own. Even the Odds helps us understand the broader implications of risk--and how it guides our decision-making--so that we can improve outcomes across multiple facets of our lives, from our businesses and investments, to the personal choices we make.

Part 1
Sensible Risk-Taking

Chapter 1
Right Size Your Risk

Over the course of my career, risk has been my ever-present companion. Risk is well recognized and acknowledged, studied intensely from Wall Street to the halls of academia. Despite the contemplation and analysis, there remains a void in practical suggestions for how to handle mainstream risk-taking.

Too often, we ignore certain risks and disregard the possibility of unhappy consequences. The tenets I've outlined in Even the Odds are designed to improve decision making and help you avoid dire pitfalls. The allure of rewarding outcomes drives and often manipulates our perception of risk. Whether you are beginning to invest in emerging markets or are thinking of giving up your Wall Street job to teach, the results of major life changes are steeped in uncertainty, and the process of evaluating potential costs and benefits is daunting. Our pursuit of big rewards in all aspects of life can distort our ability to carefully consider a reasonable course of action.

My proficiency in balancing risks and rewards is perhaps my greatest core strength, and my experiences as an investor, a business owner, and a wife and mother of four have enabled me to distill principles of risk-taking that can be applied universally. These tenets—right sizing, right timing, relying on knowledge and experience, and remaining skeptical—have been effective in guiding my decisions both when I wrangled with international financial crises and when I had to choose a jogging partner. While the four principles are often interlaced in practice, one tenet frequently dominates the analysis, and it is helpful to isolate each as we discuss them.

The first tenet, right sizing, guides the scope of the risk you will incur. This risk might be monetary, emotional, or measured in time, effort, or energy For example, there may be an oversized risk in taking a high-paying job that requires an hour drive each way if you tend to get sleepy at the wheel after thirty minutes. On the other hand, counseling your soccer-playing high school daughter to give the goalie position a chance is a reasonable bet: she might more easily make the varsity squad as a goalie, and she could always move back to defense. Individuals often have difficulty grasping how much may be at stake, even when they have a good sense of the potential reward or benefit they are seeking. We all have experienced problems with right sizing a risk. Following is one such problem that my firm faced a few years ago.

Setting the Structure

In 2005, I cofounded Aureus Asset Management, the firm for which I now serve as CEO, with my friend David Scudder. We created our company to offer families and individuals a means of investing using a style we call a "contemporary endowment model." Universities and nonprofit institutions had, for decades, invested across a wide range of assets, including domestic and international stocks, bonds, hedge funds, and liquid assets including real estate, private equity, and venture capital. Our goal was to do the same for individuals.

When making an investment, we carefully research each candidate and only take a position when we are convinced that a particular stock is a promising addition. We read all the financial information available on the company, review its SEC filings, and study the competitive landscape. Then we talk to the management, visit the headquarters, and build a detailed model of the future earnings and cash flow of the company. After all that, we discard at least 80 percent of the ideas because they do not offer enough reward given the cost.

We own no more than thirty-five to forty different stocks, so a new position would make up 2 or 3 percent of our clients' entire stock portfolios. After studying the benefits of diversification and attributes of concentration, as well as other factors, we determined early in our history that this was the right size for our positions. Each holding, though not particularly large, represents valuable "real estate" that we populate carefully.

Taking the Plunge

Although the return on our investment is the most important quality on which we are judged, there are sometimes additional factors and risks related to our clients' objectives. Halliburton represented such a case. In 2012, we began to study Halliburton, an oil services company whose past acts of environmental negligence had tarnished its reputation, even among conservative Americans who typically ignore such indictments. Former vice president Dick Cheney, who led the company from 1995 to 2000, staunchly denied every allegation of toxic dumping and violation of numerous federal and state regulations.¹

Halliburton's alleged transgressions went far beyond dumping and polluting, however. On April 20, 2010, an explosion at the Deepwater Horizon drilling rig in the Gulf of Mexico killed eleven workers and injured sixteen. Halliburton had provided the cementing of the wall of the rig, which was owned by Transocean Drilling and operated by British Petroleum. Following the disaster, the stock prices of each of these participants, as well as all other players in the Gulf of Mexico energy sector, plummeted.

Our research team began to do some work on Halliburton, sensing that the worst news was behind it, though the stock had barely recovered since the spill. Though the company faced ongoing lawsuits related to dumping and transporting toxic chemicals, we sensed that Halliburton might be an attractive investment. The management sounded committed to more environmentally compliant behavior.

The stock was priced comparatively low relative to its industry peers on many financial metrics. The economy was recovering, and as it did, the price of oil was moving higher. We decided to buy Halliburton, paying between $27.99 and $42.07 per share over several months. We sized the position slightly over 2 percent for our accounts, a nod to the fact that the shares were volatile; we figured we could add more if the stock were to correct from that level. Fortunately, after fluctuating during the first half of 2012, Halliburton began a sustained uptrend.

Listening for Risk

Nearly two years after our investment in Halliburton, we were meeting with the investment committee of one of our largest nonprofit clients, a West Coast institution that owns and operates a beautiful nature reserve. The new chair of the committee explained that he had a problem with the trust owning stock in companies considered irresponsible and repeat environmental offenders, particularly in light of the organization's mission as steward of a forest and wildlife sanctuary.

We'd had a very strong relationship with the previous head of this group, who was a member of the family that established the gardens, but we knew little about the new chair. He had a specific problem with Halliburton in the portfolio. We outlined the rationale behind our ownership but had no success changing his mind. The investment committee promptly informed us that we needed to sell the stock before the end of the year. We had eight more months, which was plenty of time. We assured the committee that, of course, we would comply with their wishes.

Oil service stocks have a strong correlation with the price of oil; the higher the amount realized for each barrel drawn from the ground or ocean, the more exploration companies are willing to pay for its extraction. As the spring progressed, the price of oil moved higher. Sanctions against Russia because of its military actions in Ukraine and Crimea, and the crippling of several oil fields in beleaguered Libya and Iraq, helped constrain the estimated supply. Traders pushed the price of crude higher. By June, a barrel of West Texas intermediate crude sold for nearly $106. Other than the wild speculation of 2008, when crude skyrocketed in a summer spike to nearly $150 a barrel, this was close to an all-time high. In hindsight, this would have been the perfect time to eliminate the Halliburton stock, but neither my partners nor I felt strongly enough about an imminent price drop to spearhead the sale.

We were not thinking clearly about right sizing our risk, which was much more than the price of Halliburton stock. The true risk was in losing the account, which was one of our largest.

Heeding the Warning

As the summer of 2014 progressed, oil prices drifted lower. The main culprit was the huge fracking-based incremental U.S. oil supply flooding the market. In addition, Middle East output remained steady. On the flip side, economic weakness in Europe depressed demand. Even if the Europeans were eager to stock up on oil, the strengthening dollar, in which oil is priced, was making each purchase costlier.

In early September of 2014, we again hosted the four-person nature preserve investment committee to our office for a review. The performance of the account had been very strong but the chair quickly raised the fact that Halliburton was still in the account. We noted that the mandate had been to sell the stock before the end of the year and we intended to do just that. I was able to interject that the stock was up 78 percent from the time of the purchase, but I heard muffled chuckling about how sometimes good outcomes result from bad decisions.

After the meeting, a few of us gathered in my office to discuss the risks in the portfolio with regard to the stocks, oil prices, and client retention. The United States and other world economies were in a recovery mode, which was positive for the commodity, but the supply picture was a major negative.

I then brought up the idea of selling Halliburton immediately to ensure we kept the nature preserve account, underscoring the true scope of our risk. The stock had fallen from a high of $73 in late July to the middle $6Os. A couple of my partners argued that the stock might rally in the coming weeks, a reaction to extreme selling pressure in the energy sector. I agreed to call a friend who works in the oil industry to gauge his impression of the pricing environment, and then we would make a decision.

My contact in the oil industry assured me that oil would not possibly fall below the mid-$70s per barrel, which may not have been a meaningful drop to him, but it was more than 20 percent below where we were at the time.

Assessing the Options

Reflecting on our possible courses of action, I described four potential outcomes to my partners. We knew that the committee did not want to own Halliburton, requiring a sale by year-end. Holding the stock was extremely risky. What if we held it and the stock went down? We would almost definitely lose the account, which generated an important fee.

If Halliburton climbed higher after we sold it, I was sure that no one on the committee would even notice. The same was true even if we held the stock and it advanced through year-end. At a 3 percent weight in the portfolio, there was virtually no upward move that could warrant retaining the position. The committee would not care. If we sold and the stock continued to decline, we would receive no credit, as they were the ones demanding that we divest the holding.

The answer was obvious to me: sell now. My partners agreed, and we sold the Halliburton stock in September for a 72 percent overall gain.

What happened? The price of West Texas crude continued to plummet, falling below $50 a barrel in early 2015, and Halliburton stock plunged to $37. We sold all our Halliburton holdings company wide before it reached that level, but wished we had acted as quickly for everyone as we did for the nature preserve. The most respected energy players were caught blindsided by this descent, although everyone with twenty-twenty hindsight admits that the signs were there.

This decision was not about predicting the stock price or the direction of crude oil, however, but about evaluating the size of the risk associated with not listening to the client's preference for environmentally responsible investing. The true scope of the risk was losing an important account; the clock was ticking, we knew the client's wishes, and we were all skeptical about the experts' opinions on oil prices. Once we analyzed the decision carefully, we knew that we had no option other than to sell the stock. Upon informing the committee we had sold the Halliburton, we received little more acknowledgment than "Good." That response was far better than hearing, "You're fired," a distinct possibility if we failed to right size the risk.

Beneath the Radar

I would never call myself a daredevil or characterize myself as personally reckless in any meaningful way. I might jaywalk in downtown Boston, but only when it would be impossible for anyone to drive fast enough to hurt me or when there are no cars in sight. I have never driven when I am intoxicated, not only because I don't really like to drink, but also because I don't want to risk getting caught, losing my license, or causing an accident. I would never swim at a beach if someone told me he had spotted a great white shark the day before, and I canceled a plan to learn to skydive when two people died at the facility where I was going to take lessons.

However, I did go to work on the day of the lockdown in the aftermath of the Boston Marathon bombing. That chilling event, on the afternoon of April 15, 2013, shocked everyone in the city of Boston and beyond. It is amazing and horrifying to contemplate the enormous risk, which these runners were not aware of. Around two o'clock on the afternoon of the marathon, I had driven across Commonwealth Avenue, one of the main thoroughfares on which the race is run, on my way from work to a funeral. I saw the racers and felt slightly, though not very, jealous.

Growing up, I lived a few blocks from the marathon route. Every year on Patriots' Day, a state holiday in Massachusetts, my mother and I would walk to Cleveland Circle to see the runners turn from Chestnut Hill Avenue onto Beacon Street for the final few miles of their journey I have also run the Boston Marathon and, as anyone who has run a marathon can tell you, it's exhilarating but, man, it's not easy. As a friend of mine who has run about thirty marathons says, if you finish, you beat all those good runners who sat out the race that day.

On that gorgeous April afternoon, two bombs went off within seconds of each other at 2:49 p.m., killing three people and injuring 264. At the memorial service I was attending that afternoon, people started getting text messages from friends and family asking if they were okay. The whole city was in a state of shock and the suspects remained at large for several days.

Finally, in the early evening of Thursday, April 18, FBI Special Agent Richard DesLauriers and Carmen Ortiz, the United States Attorney for Massachusetts, held a press conference and reported that they had identified two suspects whom they believed had set off the bombs. As Agent DesLauriers spoke, a video of the two young suspects moving across the screen played eerily over and over. His voice calmly stated that the suspects were likely armed and dangerous. Soon after the video aired, the tip line began to ring.

Friday I went to my 6:15 a.m. spin class, but while changing after class in the locker room, a staff member ran in to tell us that the gym was closing, we needed to leave, and it had something to do with the marathon bombing.

I got in my car and listened to a radio broadcast that said the suspects had killed an MIT campus policeman the night before, then engaged in a shootout with the police in Watertown, a city adjacent to Boston on the northwest side. One suspect was killed and the other had escaped, so the authorities were going door to door in Watertown. Because of the urgency of the search, Governor Deval Patrick requested that citizens in adjoining cities and towns "shelter in place" for the day.

Despite the official warning, I decided to go in to my office, which is five or six miles from Watertown. I estimated that the risk of being injured was no greater than on any other day, and probably less because there were fewer cars on the road. I likewise decided I would not impede the investigation from such a distance. I evaluated the size of the risk to me and to other individuals as extremely small. So, I drove to work believing that the scope of potential danger to me or caused by me would be minute. Of course, if every other commuter had reached a similar conclusion, the roads would have been packed; on the other hand, most people offered a day off are very happy to take it.

There was also another factor that contributed to my decision. Jeremy Goldsmith,* a client prospect and one of the city's most successful lawyers, had set up an appointment for that day and had already confirmed. Jeremy's office was only a block away from mine. Something made me think that Jeremy would also go to work that day and I was loath to e-mail him that I was staying home.

If he were in Boston and we met, I thought—perhaps optimistically—that my company had a strong chance of winning the account. When I arrived at my desk, I e-mailed my colleagues that they shoul...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Dedication
• Contents
• Introduction
• PART 1 Sensible Risk-Taking
• PART 2 Business
• PART 3 Investing
• PART 4 Life
• Epilogue
• Acknowledgments
• Notes
• About the Author