Comments on: To Hedge or not to Hedge http://ozrisk.net/2007/07/18/to-hedge-or-not-to-hedge/ Risk Management in Australia Tue, 02 Dec 2008 02:00:11 +0000 http://wordpress.org/?v=MU hourly 1 By: Andrew http://ozrisk.net/2007/07/18/to-hedge-or-not-to-hedge/#comment-22406 Andrew Fri, 20 Jul 2007 14:58:49 +0000 http://ozrisk.net/2007/07/18/to-hedge-or-not-to-hedge/#comment-22406 Ralph, Thanks for welcoming comments :). The funds managers tend to prefer no-hedge strategies as it makes a company easier to price and therefore more valuable. Additionally, in the long term hedging does cost no matter what way you do it. So, in the long term, the strategy that pays the best is not to hedge. In the long term, though, we are all dead. As fund managers normally have a broad spread of firms in their portfolio, the failure of any one firm will not greatly affect the value of the portfolio. For those of us invested in funds (and that includes all Australians in employment through our superannuation) this is a good thing. For boards, though, it is a problem. They owe a fiduciary duty to the firm - and several legal duties. Their first duty is to act <em>bona fide</em> in the interests of the firm - and that means there has to be a firm to keep running. For the last decade or so the unhedged strategy has paid well - just ask BHP. What I am saying here is that it may be time to re-appraise it. Fund managers do not (and should not) run the firm, but, as part owners, they have a right to be heard. It is the board, though, that must make the decisions. I would agree that hedging a relative percentage is a good precautionary measure - given where commodity prices are now I feel that the strategy outlined here is a good precautionary one. As for the fund managers - they have a right to be heard, as stated, and they have a right to know what the strategy is. Beyond that they only have the right to receive dividends. Ralph,
Thanks for welcoming comments :).
The funds managers tend to prefer no-hedge strategies as it makes a company easier to price and therefore more valuable. Additionally, in the long term hedging does cost no matter what way you do it. So, in the long term, the strategy that pays the best is not to hedge. In the long term, though, we are all dead.
As fund managers normally have a broad spread of firms in their portfolio, the failure of any one firm will not greatly affect the value of the portfolio. For those of us invested in funds (and that includes all Australians in employment through our superannuation) this is a good thing.
For boards, though, it is a problem. They owe a fiduciary duty to the firm - and several legal duties. Their first duty is to act bona fide in the interests of the firm - and that means there has to be a firm to keep running.
For the last decade or so the unhedged strategy has paid well - just ask BHP. What I am saying here is that it may be time to re-appraise it. Fund managers do not (and should not) run the firm, but, as part owners, they have a right to be heard. It is the board, though, that must make the decisions.
I would agree that hedging a relative percentage is a good precautionary measure - given where commodity prices are now I feel that the strategy outlined here is a good precautionary one.
As for the fund managers - they have a right to be heard, as stated, and they have a right to know what the strategy is. Beyond that they only have the right to receive dividends.

]]> By: Ralph http://ozrisk.net/2007/07/18/to-hedge-or-not-to-hedge/#comment-22403 Ralph Fri, 20 Jul 2007 13:52:37 +0000 http://ozrisk.net/2007/07/18/to-hedge-or-not-to-hedge/#comment-22403 Today's Board's are driven by shareholder requirements - with large fund managers preaching the non-hedge philosophy. A relevant question is why then do fund managers then take out hedging to protect downside risk in an investment with exposures to interest rate, foreign currency movements or commodity prices? A classic example would be a large fund manager with exposure to a gold mining company's share price taking out gold swaps in the background to hedge their exposure to the gold price inherent in the share price. Does this make sense? Of course not as fund managers do not live by the rules they preach. In reality if commodity prices dropped sharply and the currency rose sharply over coming years who is responsible should a mining company fail? The shareholder or the Board? I know the answer - the Board. Thus direct hedging by any company is important from an economic perspective to ensure a sustained future for the organisation - albeit hedging a relative percentage versus 100%. Comments welcomed. Today’s Board’s are driven by shareholder requirements - with large fund managers preaching the non-hedge philosophy. A relevant question is why then do fund managers then take out hedging to protect downside risk in an investment with exposures to interest rate, foreign currency movements or commodity prices? A classic example would be a large fund manager with exposure to a gold mining company’s share price taking out gold swaps in the background to hedge their exposure to the gold price inherent in the share price. Does this make sense? Of course not as fund managers do not live by the rules they preach. In reality if commodity prices dropped sharply and the currency rose sharply over coming years who is responsible should a mining company fail? The shareholder or the Board? I know the answer - the Board. Thus direct hedging by any company is important from an economic perspective to ensure a sustained future for the organisation - albeit hedging a relative percentage versus 100%. Comments welcomed.

]]> By: Andrew http://ozrisk.net/2007/07/18/to-hedge-or-not-to-hedge/#comment-22383 Andrew Fri, 20 Jul 2007 02:20:43 +0000 http://ozrisk.net/2007/07/18/to-hedge-or-not-to-hedge/#comment-22383 Bruce - well put. Eliminating risk is expensive. Managing risk to a level you are comfortable with need not be. Bruce - well put. Eliminating risk is expensive. Managing risk to a level you are comfortable with need not be.

]]> By: bruce http://ozrisk.net/2007/07/18/to-hedge-or-not-to-hedge/#comment-22361 bruce Thu, 19 Jul 2007 15:03:50 +0000 http://ozrisk.net/2007/07/18/to-hedge-or-not-to-hedge/#comment-22361 Great article Andrew. I'd taken hedging to be the elimination of risk by covering the negative risks to your business such that profitibiliy is dependable and consistent, and less boom/bust. I assumed some form of optioning was usually the method but I now appreciate the cost would be very high to eliminate risk but acceptable where the goal is to limit risk to a manageable level. very well explained. Great article Andrew.

I’d taken hedging to be the elimination of risk by covering the negative risks to your business such that profitibiliy is dependable and consistent, and less boom/bust. I assumed some form of optioning was usually the method but I now appreciate the cost would be very high to eliminate risk but acceptable where the goal is to limit risk to a manageable level.

very well explained.

]]>