Bill Gross: investment manager, billionaire, neg on US government debt

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Rightly or wrongly, I believe that entrepreneurial billionaires didn’t become so merely by pure luck but rather they have been able to correctly assess their market more often than not. If we assume this, it is rather revealing that Bill Gross, founder of PIMCO and manager of the world’s largest bond fund ($236 USD billion) has not only reduced his US government debt to zero but has now begun to short government debt. For those unfamiliar with this concept, going short is when you sell something today in the belief that the price will fall so that you will be able to buy back that good in the future at a lower price; the difference being your profit. For Mr. Gross to make money he needs the price of US debt to fall, in other words he needs interest rates to rise. Interest rates can rise because of inflation or a lack of faith in the debt issuer (see other RSD blogs on government debt).

In combination with going short, Mr. Gross is currently holding almost 31% cash in the bond fund, further proof of his belief in future rising interest rates. 

As numerous others have stated the days of cheap capital will inevitably draw to a close.  When is uncertain, but hedging of interest rate exposure should definitely be moving towards top of mind for risk managers.  The contagion of European debt is not complete and as forecasted by some it could conceivably cross “the pond” later this year.  Stay tuned.

 

For more on this click on the link to Tyler Durden’s blog at Zero Hedge:

http://tinyurl.com/5uh838b

 

Widgets or Trading?

Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Many of the corporate managers that we talk to take the position that it is there job to forecast financial markets.  That may very well be if they are currency traders, or commodity brokers or derivative structurers.  The plain truth however is that most managers are responsible for some part of the process of making and selling widgets of some sort.  While the making and selling of widgets probably involves elements of the financial markets, that is not the main goal of the corporation.  For instance – does Kellogg’s sell Corn Flakes because they speculate that the price of corn is going to fall?  Of course not!  Thus why do manufacturing managers still think it makes sense to try to time the market with their purchases and their hedging strategies?  If they had that skill they should be hedge fund mangers!

 

Shadow Risk Portfolio

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

One of the training tools for investors and investor wanna-bes is the shadow portfolio – or sometimes known as a paper portfolio.  A shadow portfolio is where the investor practices their trading by making trades “on paper” – that is recorded in a notebook, but never having executed the trades for real.  The trader however follows the valuation of their trades just as if they were done with real money, and this way they get investment experience without the “investment tuition”. 

Would it not be a great idea for corporations to also have a shadow risk portfolio – that is a set of strategies that they might be too timid to execute in real life, but they execute on paper – recording their hedging tactics and then tracking the results versus their “do-nothing” strategy.  This would allow corporations to gain valuable experience in hedging that they may not be willing to execute otherwise due to their fear of being wrong, or their lack of understanding of how the products might behave under various scenarios. 

A few years ago, RSD Solutions conducted a back-test for a corporation that wanted to see how a change in their hedging strategy would have worked.  They basically knew that how they were currently hedging was ineffective, but no one in the corporation wanted to be the first to attempt or even suggest a new strategy.  We conducted the study and showed them in clear and easy to understand terms how a different hedging strategy would not only be more cost effective, but would also hedge them in a way that was more consistent with their financial strategy and corporate goals.  The CEO, CFO and Board quickly approved a change in strategy once they saw how much a simple change in hedging tactics would improve the bottom-line and help unit managers with their planning. 

Not implementing a hedging strategy is more often a function of lack of inertia.  Creating a shadow portfolio is one way to get the ball rolling.

You aint seen nothin’ yet ….

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

So the U.S. government didn’t shut down thanks to an agreement to cut an extra $38 billion of spending (compared with deficit of around $1.4 trillion).  We’ve been here before and life has always gone on.  However, perhaps a more frightening situation is coming up.  The U.S. is about to hit its legal debt ceiling of $14.3 trillion which is getting on towards 100% of GDP.  These numbers just beggar belief.  The U.S. is now the only major economy with such debt and deficit problems that has not introduced some sort of realistic austerity program so the situation keeps getting worse.  Other stats can be quoted that compound the grief – or determination to act – that perhaps should be felt. 

Of course, we’re constantly told that the U.S. is different.  The economy has unequalled potential, it always grows, foreign investors hold so much U.S. debt that if they didn’t keep buying it, their investment would lose value, etc., etc. 

Nobody expects a U.S. debt default but more and more people mention the possibility before coming up with the aforementioned reasons why it will not happen.  But, surely the party cannot go on forever.  Something has to give and with the American form of dysfunctional government, it may take some external event or shock to cause the very painful action required. 

This of course would affect, not only the U.S. dollar but many, if not all other currencies in terms of volatility.  I will leave open the question of: what should companies be doing?  As a partial answer, companies should be thinking very seriously about various scenarios.  They should know and understand their currency and interest rate exposures in a far more detailed, scientific and meaningful way than the traditional “have a handle in my head” of the CFO’s and treasures of many businesses. 

I will expand on this in coming blogs but it would be interesting to have some discussion of how big an issue others see this as being.

Managing through Complexity. A Free Dalhousie University "Lunch and Learn" with Rick Nason in Ottawa, Toronto

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

This week as part of a cross Canada out reach, Dalhousie University's Faculty of Management is offering an Executive Leadership Series of talks in Ottawa and Toronto.  

 

This week, Rick Nason, Associate Professor in Finance will be hosting two free lunch and learn events looking at business risk but through the thought processes of science.  This interesting mash-up of disciplines recently gained Mr. Nason a featured article in the Risk Management Association Journal - the prestigious and thought leading journal in the area of risk management and strategy.

Seminar dates and locations:

• Wednesday, April 13– Ottawa at the RBC Royal Bank, 90 Sparks Street, 2nd Floor
  
•  Thursday, April 14 – Toronto at the RBC Royal Bank, 20 King St W, 10th Floor

We hope you can make it and remember – it’s free!

 

For more information and registration for this free event and the series follow the link:

 http://bit.ly/fVbTVG

Planting a Tree

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com 

info@RSDsolutions.com

 

 

 

We have all heard the story about when the best time to plant a tree is – as soon as possible.  Waiting to plant a tree only delays the time it takes for the tree to reach maturity.

 

The same can be said for when is the best time to implement a hedging strategy – as soon as possible.  Yes – it is true that rates may move favourably later, but more often than not they don’t.  Yes – it may be true that hedging costs have gone up, and the horses have already left the barn, but without the discipline to put the hinges back on the barn door, it will not be possible to corral the horses in the barn if the barn door is not repaired and the horses do return – besides, there are likely pigs and other animals that still need shelter.

 

Just as right now is always the best time to plant a tree, right now is generally always the best time to ensure that you have a conscious hedging plan in place (which by the way, may or may not involve the use of financial products).

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign Exchange Wrecking Ball

by Stephen McPhie, CA

Partner, RSD Solutions Inc

www.RSDsolutions.com

info@RSDsoulutions.com

 

 

If currency exchange rates have been volatile over the last few years, we are possibly looking at volatility squared over the next few years.  Portugal is joining Greece and Ireland in being bailed out.  These economies are relatively very small in the Eurozone.  However, many are wondering if Spain and then Italy will be in the cross hairs next and these are not small in the scheme of things.  Certainly Spain looks much better in many ways than Portugal but an employment rate in excess of 20% is a massive burden. 

 

Having been an observer and sometimes a victim of several economic cycles, I know that events, markets and politics can gain an unstoppable negative momentum.  Prices and rates tend to overshoot their proper level and correct, usually with little disruption on a macro scale.  However if a giant wrecking ball overshoots, it can knock down several buildings and that is a whole lot more difficult to correct.

 

Add to this the increasing number of voices expressing doubt over the whole future of the Euro itself, especially in the 2 large triple A rated Eurozone economies of Germany and France.  Especially so in Germany where more and more people are disquieted over the prospect of paying a high price to prop up much less developed Eurozone countries in order to save the Euro.

 

The Euro itself was a political creation.  It was weakened in its earlier days by Germany and France ignoring the fiscal rules.  Politicians are trying hard to ensure survival of the Euro.  For now, that is.  However, politicians do not always operate in a long term economically optimal way.  After all, politicians’ careers depend on voters in their own country at the next election and not on wider Eurozone’s economics.  Political winds can change direction very quickly.

 

All this suggests increasing exchange rate volatility.  While it does not appear likely that the Euro will die in the near term, there is a giant wrecking ball swinging around that has the ability to knock down a few houses.

 

Do you really have a handle on your company’s FX exposures?  Do you know the natural hedges and economics of your derivative hedges?  Have you done a full and proper evaluation of all this?  I have seen many companies that are comfortable with their positions until that giant wrecking ball comes crashing through the wall.