"Kipling" Anxiety?

Written by: James Bennett
Date posted: 26-05-22
Kipling - Never look backwards.

Common sense advice or an observation on the power of perspective and nature of futility? Hard to know with absolute certainty as Kipling has, not ironically, been dead some time. However, I find these words very poignant in relation to the current economic tides that are washing through the market and causing incredible volatility at every turn.

Don’t look backwards means do not dwell too long on the past and prepare for the future. Learn from the past inasmuch as it helps you to navigate the future, but no more than that.

Foreign Exchange (FX) markets are unpredictable and move quickly. Most companies are not in the business of speculating and must be able to survive even when markets move. To understand exposure to FX market moves, it’s first important to look forwards (i.e. don’t look backwards) and understand what the impact could be on your underlying business (lest you fall down the stairs). Do not consider what your exposure was in the past; understand what it is today. Ask yourself questions such as:

- Over what time horizon can you pass price changes onto your underlying clients and customers?

- For some companies, as FX rates change so do the prices of their goods and services.

- Other companies can only pass-on prices periodically when they publish new brochures, so are exposed to rate changes in-between times.

- How much of your cost / profit is dependent on currency? If your input costs are 90% domestic and only 10% non-domestic, then currency moves will have very little impact on your costs or profits.

- What gross profit margin do you operate at? If you have double-digit gross profit margins then you have a significant cushion against FX rate changes. But if not…

- Do you have any internal offsets? Missing out on natural hedges is surprisingly common especially where companies operate in disparate group structures.

We will ask you those questions anyway, but it’s not rocket-surgery.

Finally, a word on hedging using options. Keep your real-world options open, but think carefully before using regulated FX options in your business. These instruments need a high degree of expertise and focus. They can also cause you to look backwards at their performance (rather than forwards), and they very often change the focus of your regret. Very few businesses use them anymore anyway because they are a headache for the auditors. If you want to use them then we can point you in the right direction, but you might very well be better-off concentrating on looking forward and driving your underlying business.

Just to book end this piece with another Kipling quote from his uplifting poem but slighty adjusted to reflect modern times “If”…

“If you can keep your head when all about you are losing theirs”….you may have misjudged the severity of the situation.