Active currency management around a currency benchmark means the fund has given either the asset manager or a professional currency overlay manager the mandate to “trade” the currency around the currency hedging benchmark for the explicit purpose of adding alpha to the total return of the portfolio.
With active currency management, the emphasis should be on flexibility, both in terms of the availability of financial instruments one can use to add alpha and also in terms of the currency hedging benchmark. On the first of these, an active currency manager should have access to a broad spectrum of currency instruments in order to boost their chance of adding value. Similarly, their ability to add value is significantly increased by the adoption of a 50% or symmetrical currency hedging benchmark rather than by a 100% hedged or 100% unhedged benchmark.
Active Currency Management
July 5th, 2011 No comments »RELATIVE RETURNS — ADDING ALPHA
July 4th, 2011 No comments »Asset managers who are focused on absolute returns when managing their currency risk tend to use strategies that are characterized by risk reduction, adopting a passive currency management approach in order to achieve this. By contrast, funds that are focused on relative returns tend to manage currency risk more actively. Their aim is after all to outperform an unhedged position, or in some cases the hedged benchmark, in other words to “add alpha”. In this, there is no “right” and “wrong”. It depends completely on the risk management style of the fund and what risk approach it takes towards both the underlying assets and also the embedded currency risk.
SELECTING THE CURRENCY HEDGING BENCHMARK
July 3rd, 2011 No comments »A crucial decision for portfolio managers who want to manage their currency risk, whether actively or passively, is the selection of their currency hedging benchmark. After all, when we are talking about managing currency risk, we are really talking about establishing whether or not there may be a need to hedge out that currency risk. Using a currency hedging benchmark is a more disciplined and rigorous way of managing currency risk than either not hedging or at the other extreme conducting all currency hedging on a discretionary and “gut feel” basis. There are four main currency hedging benchmarks used by institutional investors, which can be divided into:
100% hedged benchmark
100% unhedged benchmark
Partially hedged benchmark
Option hedged benchmark
Being 100% hedged is usually not the optimal strategy, apart from in exceptional cases. Equally, using a currency hedging benchmark of 100% unhedged would seem to defeat the purpose of managing currency risk, again apart from in exceptional cases. A further consideration is that many funds are not allowed to use options as they are viewed as a speculative financial instrument, ironically in the same way that some corporations are also not allowed to use them. This still leaves them however with the choice of three possible currency hedging benchmarks of 100% hedged, 100% unhedged or partially hedged. The primary instrument for such hedging would be the forward for passive currency management, though active currency managers would no doubt have greater flexibility, both in the currencies in which they can operate and the financial instruments they can use.
Currency hedging benchmarks of 0% or 100% are known as asymmetrical or polar benchmarks and have obvious limitations. With a polar benchmark, an active currency manager is able to take positions only in one direction. As a result, their ability to add value is also limited. For example, it is extremely difficult for a currency manager to be able to add value operating under an unhedged currency benchmark when foreign currencies are appreciating because the manager is generally unable to take on additional foreign currency exposure. The best the manager can do is to mimic the benchmark by holding the unhedged benchmark exposure and avoiding hedging. Similarly, when operating under a fully hedged benchmark, it is difficult for a manager to add value when foreign currencies are falling.
Adoption and use of benchmarks depends critically on the currency risk management style, for which the type of fund is clearly a key determinant. For instance, a pension fund manager may use a fully hedged or alternatively unhedged currency benchmark to either reduce risk on the one hand or minimize transaction costs on the other. Meanwhile, the active currency manager will seek a partially hedged benchmark, preferably 50%, to give them as much flexibility and room as possible with which to be able to add value. With such a symmetrical benchmark, active currency managers can take advantage of both bull and bear markets in their currencies. In the context of relative returns, it should therefore be of no surprise that there is good evidence to suggest that symmetrical benchmarks have consistently added more “alpha” than their asymmetrical counterparts.
Risk Reduction
July 2nd, 2011 No comments »The emphasis on risk reduction within a passive currency management style deals with the basic idea that the portfolio’s return in the base currency is equal to:
The return of foreign assets invested in + the return of the foreign currency
This is a simple, but hopefully effective way of expressing the view that there are two separate and distinct risks present within the decision to invest outside of the base currency. The motive of risk reduction is therefore to hedge to whatever extent decided upon the return of the foreign currency. From this basic premise, we can extrapolate the following:
Return (unhedged) = Return (asset) + Return (currency)
and
Return (hedged) = Return (asset) + Return (hedge currency)
The overall aim remains the same, and that is to reduce the overall risk of the portfolio, maximizing the total or absolute return in the process. In other words, it is to boost the portfolio’s Sharpe ratio, which is usually defined as the (annual) excess return as a proportion of the (annual) standard deviation or risk involved.
It should be noted from this formula however that some investors balk at the idea of hedging on the simplistic view that the hedge cost automatically reduces not just the hedged return of the asset but the asset’s total return in base currency terms. This is not necessarily the case. Actually, the converse can be argued, namely that the hedge reduces or eliminates any possible currency loss. Whether or not the investor hedges, there is the foreign currency return to be considered. That may add or detract from the asset return in foreign currency terms, and therefore may in turn boost or reduce the asset return in domestic currency terms. The hedging cost component will clearly depend on a number of variables, including the currency hedging benchmark and the financial instruments that can be used, but has clear parameters. The potential unhedged currency loss is theoretically limitless.
ABSOLUTE RETURNS — RISK REDUCTION
July 1st, 2011 No comments »Just as a corporation has to decide whether to run their Treasury operation as a profit or as a risk reduction centre, so a portfolio manager has to make the same kind of choice. While one can theoretically change one’s core approach to managing the portfolio at any time, it is usually better to make that choice right at the start. In the process, the portfolio manager should decide what style of portfolio management is to be adopted as regards the underlying investments, the desired return profile of the portfolio and also the style of currency management to be used. In the case of a portfolio manager who is focusing on absolute returns, the currency risk management style that is synonymous with this focuses on reducing the risk of the overall portfolio. This in turn usually means adopting a passive style of currency risk management.
What’s the fastest way to repay debt?
February 10th, 2011 No comments »We’d all like to be able to repay our debts a little faster, but the reality is that most of us don’t really give a lot of thought to this. Most people will only ever repay their debts as their terms dictate, failing to realise that a few overpayments could reduce the overall amount they have to pay.
But if you do want to repay your debts more quickly, then using additional cash to ‘overpay’ on your debts can be a good idea. Here are a few tips for clearing your debts faster.
Repaying debts in the right order
The key to reducing the total amount you pay – and therefore how fast you can repay your debts – is repaying them in the right order. More specifically, this means repaying the debts with the highest interest rate first, and gradually working your way down to the debt with the lowest rate.
This doesn’t mean only repaying the debt with the highest rate – you will obviously have to make at least the minimum repayments on all of your debts. But any excess income should go towards overpaying on the debt with the highest rate (usually online payday loans) , as far as your repayment terms will allow.
The maths behind this are quite simple: repaying high-interest debts faster means they take less time to repay, meaning you’ll be charged a high rate for a shorter period.
Some people feel that this method of repaying debt can be discouraging because it could take longer to clear the first debt in full than if you started with smaller debts, but it is certainly the cheapest way of repaying what you owe.
Note: if you’re a credit card borrower, your provider is now required to repay your debts in this order. More details on this can be found at http://www.uswitch.com/credit-cards/order-of-payment/.
Increasing you amount you can pay each month
If you really want to speed up the amount of time it takes to repay what you owe, then you may find that a few improvements to the way you manage your finances can free up extra cash.
A few ideas might include putting together a strict budget to give your finances a bit more structure (reducing unnecessary spending), or generally cutting back on a few things you don’t need. Both these things could raise additional cash for overpayments towards your debts.
You can find more tips on ways to beat debt at http://www.debtadvisorycentre.ie
Short Selling
November 16th, 2010 No comments »Short selling involves the sale of a security not owned by the investor at the time of sale. The investor can arrange to have her broker borrow the stock from someone else, and the borrowed stock is delivered to implement the sale. To cover her short position, the investor must subsequently purchase the stock and return it to the party that lent the stock. The investor benefits if the price of the of the security sold short declines. Two costs will reduce the profit on a short sale. First, a fee will be charged by the lender of the stock. Second, if there are any dividends paid, the short seller must pay those dividends to the lender of the security.
Exchanges impose restrictions as to when a short sale may be executed; these so-called tick-test rules are intended to prevent investors from destabilizing the price of a stock when the market price is falling. A short sale can be made only when either (1) the sale price of the particular stock is higher than the last trade price (referred to as an “uptick trade”), or (2) if there is no change in the last trade price of the particular stock (referred to as a “zero uptick”), the previous trade price must be higher than the trade price that preceded it.
Dividends
November 16th, 2010 No comments »American companies may periodically declare cash and/or dividends on a quarterly or yearly basis. Dividends are provided to the shareholders— otherwise referred to as stockholders—as an income stream that they can rely on. This is quite similar to a bank paying interest on certificates of de- posit (CDs) or savings accounts. There are a number of companies that boast that they have never missed a dividend or have always increased dividends.
Companies that distribute their income as dividends are usually in mature industries. You typically will not find fast-growing companies distributing dividends, as they may need the capital for future expansion and may feel they can reinvest the funds at a higher rate of return than the stockholders. As a stock trader, you need to know how this process affects your long or short investment. Basically, a company’s board of directors will decide whether to declare a dividend, which is paid out and distributed to shareholders on a date set by the company. Also, some companies will declare a special dividend from time to time. This dividend is paid out and distributed to shareholders on a date set by the company, referred to as a payable date.
In order to qualify for a dividend, you must be a shareholder on record as of the record date (the date you are “recorded” as the owner of the shares) of the dividend. You can also sell the stock as soon as the next day after the payable date and still receive the dividend.
A beginner may think this is a profitable way to buy and sell shares: Buy the shares a few days before the record date and sell them on the day after the payable date. However, before you run out and open a stock brokerage account in order to implement this tactic, you may want to con- sider that, in most cases, the stock prices will be trading lower on the day that the dividend is payable. That’s because on the dividend payable date (i.e., the date on which you get paid the dividend), the stock should trade at its regular price minus the dividend.
Let’s consider an example. If IBM (IBM) declared a $1 per share dividend payable on June 30, and closed at $90 on June 29, then on June 30, IBM would open at $89. As a stock trader, it is important to be aware of dividends and how they can affect a stock. You can find stocks declaring dividends by looking in the newspaper financial pages or at various financial web sites.
Industry Profiles
November 15th, 2010 No comments »Investor’s Business Daily regularly carries either a profile of a company or an industry that can provide a wealth of information. These profiles are helpful tools in the search for companies and/or industries where consolidation (takeovers) is taking place. Very often you will find that IBD is profiling a company that has been on the acquisition trail itself or that operates in an industry where takeovers are taking place. Since we already know that IBD is partial to the larger, higher-profile companies, you will usually find that the companies profiled in this section are larger companies that have been buying other companies rather than potential takeover targets. But that’s fine, because by reading the profiles of companies like this, you can often get a feel for the reasoning behind the takeover trend in a certain industry. Not only that: When IBD profiles a company that has been acquiring other companies, you will often find a detailed explanation of the reasoning behind these takeovers, and on occasion the CEO of an acquiring company will offer a set of clues as to where that company might be looking for future takeover targets.
Another extremely useful aspect of the industry profiles section is a listing of companies that operate within the industry being profiled. Headlined “Who’s Who in the Group,” this list of companies provides an excellent starting point for superstock sleuths who may be seeking takeover candidates within that particular industry.
This list of industry participants is also useful because IBD will often note various takeover transactions that have recently taken place within the industry. For example, on August 16, 1999, IBD’s
industry profile was entitled: “Paper Products: Tighter Supplies, Consolidation Fuel Upswing in Long-Suffering Industry.” The story talked about the recent trend toward takeovers in the industry and contained a table of 25 companies operating within the paper and paper products industry, including three notations on takeover trans- actions involving Kimberly Clark, Boise Cascade, and Pope & Talbot.
When I encounter a story like this in IBD, my tendency is to focus on the mid-size and smaller companies in the industry, based on two premises. First, if a consolidation trend is taking place and the larger companies in an industry are getting bigger and more cost-efficient, the mid-size to smaller companies in that industry are likely to be more receptive to being acquired. Second, the smaller companies in any given industry are less likely to be overfollowed and overanalyzed by Wall Street, which increases the probability that there will be bargains among them relative to their takeover potential.
Of course, Investor’s Business Daily, which focuses on relative strength, earnings momentum, and other characteristics of stocks that are already currently in vogue and in the forefront of the market, cannot simply list the industry participants from top to bottom in terms of size, based on revenues or market capitalization. Instead, IBD lists the companies from top or bottom in terms of stock performance and/or earnings growth. The stocks, says IBD, are “ranked (not ‘listed,’ mind you, but ‘ranked’—this is Big Brother we are talking about, remember) by a combination of their earnings per share and Relative Strength rankings.”
So you will have to do a little reshuffling of the list if you want to focus on the smaller companies in the group.
But that’s a small price to pay for a very useful presentation, and I have uncovered quite a few takeover targets by reading IBD’s industry profiles section on a regular basis.
Cash Reserve
November 14th, 2010 No comments »Emergencies, job layoffs, and unforeseen expenses happen, and good investment opportunities emerge. It is important to have a cash reserve to help meet these occasions. In addition to providing a safety cushion, a cash reserve reduces the likelihood of being forced to sell investments at inopportune times to cover unexpected expenses. Most experts recommend a cash reserve equal to about six months’ living expenses. Calling it a “cash” reserve does not mean the funds should be in cash; rather, the funds should be in investments you can easily con- vert to cash with little chance of a loss in value. Money market mutual funds and bank accounts are appropriate vehicles for the cash reserve.
Similar to the financial plan, an investor’s insurance and cash reserve needs will change over his or her life. We’ve already mentioned how a retired person may “cash out” a life insurance policy to supplement income. The need for disability insurance declines when a person retires. In contrast, other insurance, such as supplemental Medicare coverage or long-term care insurance, may become more important.