Doing nothing is not a strategy; Canadian exporters exempted

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Recently Peter G. Hall, Vice-President and Chief Economist at the Canadian government’s Export Development Corporation stated in his weekly e-newsletter that when it comes to exporters dealing with the “soaring loonie” a survey showed that:

 

“(of the) current coping strategies, the largest group of respondents, at 28%, is simply riding out dollar movements. Cost-cutting is the preferred route for 20% of exporters, while 10% have a hedging strategy. At 7%, a small minority is having success passing on the cost of a higher dollar by increasing selling prices.”

 

So almost 50% of respondents are either effectively doing nothing or hoping that cost cutting in a commodity appreciating world will reduce the risk to their firm of feeling the pain of a strong Canadian dollar.  Cost cutting can work but sadly the costs being cut are probably adversely effecting moral, staff training or future market opportunities; as for “winging it”, that to may limit future growth and profitability. 

 

Why do so few firms go with a hedging (arguably the more sensible route for some) strategy?  The common reason we at RSD have found is a misunderstanding of the strategy or the lack of internal corporate skill sets and the discomfort of senior staff acknowledging this.  Is that where your firm stands?  And is that really a justification for doing nothing or slashing and burning operations to effectively stand still?

Old McHedgeFund now has some farms

by Michael Arbow, MBA

Partner, RSD Solutions.com

www.RSDsolutions.com

info@RSDsolutions.com

 

Occasionally this blog talks about the rising cost (real and nominal) of the soft commodities (food) and has also pointed out that farmland is becoming an alternative asset in the investment portfolios of billionaires; well it looks like hedge funds are now moving down on the farm.  It is estimated that US farm land will be increasing at a rate of between 5-10% per year in the foreseeable future.  Add onto this the return of the food grown and farmland is looking pretty attractive.  Of course the road will be rough (volatile) but the trend is entrenched as long as the wealth in China and India and numerous other emerging markets increases.

 

Where does that leave the food processors; the candy makers, the bio-fuel creators and the brewers? Well for them, the future will be filled with uncertain prices and shifts in consumer tastes towards alternatives.  Budgeting and price forecasting will become more uncertain as will consumer tastes as demand destruction begins to control the markets.  This world is no longer on the horizon, it is here and the hedge funds know it and are making plans to profit from it.  Meanwhile for commodity users: are they ready, has the risk team and the Board updated themselves with viable alternatives to reduce the worry and volatility, are hedging strategies been re-visited?  According to the attached article, time is running out.

 

For more on this story follow the link to The New York Observer article:

http://tinyurl.com/4yvgend

Martian Foreign Exchange Risk

By Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Even though I lived in the USA for several years, I still do not understand U.S. politics and politicians.  I don’t think most Americans do either.  They just seem to be born either Democrat or Republican and harbour a life-long hatred of the other that borders on vindictiveness at times.  Like many non-Americans, I just observe with amazement and never cease to be astonished about what goes on.  However for better or worse, what goes on in America profoundly affects not only Americans, but also the rest of the world.

Now that we know that the U.S. president wasn’t born on Mars (subject to forensic examination of documentation), will U.S. politicians turn their attention to making a serious attack on the deficit?  And what about the debt mountain?

 

Inflation fears are causing pressure for interest rate rises in a number of countries.  It does not appear that the Fed is yet ready to raise rates but things can change rapidly.

 

The U.S. dollar has been weak while commodity prices have been rising.  However some commentators are now opining that such process have overshot and are predicting falling commodity prices. 

 

What will happen to the Euro if the PIG bale outs become PIGS bale outs?  Or even PIGSI bale outs?  (Portugal, Ireland, Greece, Spain and Italy.)

 

And so on and so on …..

 

The bottom line is that we are facing a very uncertain situation of possible currency volatility.  Does your company have a thorough understanding of its foreign currency exposures in terms of identification, quantification and sensitivity to exchange rate fluctuations?  Do you have well-developed strategies and policies for dealing with these?  Are your hedges really effective and are you sure that they do not create additional exposures you are unaware of?

 

And if you answered yes to these questions, are you absolutely certain?  Are you sure that a yes 12 months ago is still a yes today?

Help – this roller coaster goes up and down!

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Saudi Arabia’s oil minister recently commented that he thinks the world crude oil market is oversupplied.  His Kuwaiti counterpart agrees.  They believe that prices are driven by speculation.  This is not much comfort to you and me when we fill our cars up at the petrol (gas) pump.  (Actually I personally can barely afford to fill my tank any more but that is more to do with the tax regime in Britain than world oil prices.) 

One thing that appears apparent is that when prices of anything go up or down very fast, especially if it appears that speculation is a major factor, rather than demand and supply fundamentals, they tend to overshoot and come back off their peak or low point. 

The last time oil prices peaked at a higher level than where they are now and they come off quite quickly and quite a long way.  A client who came to us after this and who suffered major losses would have been all right if their derivatives intended as hedges had matured a couple of months later.  After all, as they said, nobody would have expected prices to do what they did!  However, their “hedges” actually increased their risk.  They were unsuitable and the company did not understand them properly. 

The client would also have been better off had they done nothing.  But they would have been best off with a properly conceived hedging approach.  They should have avoided expecting or not expecting anything out of the ordinary.  The only thing that will inevitably happen is “unknown unknowns” and a risk management system should be designed with this in mind.

 

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.