Many a times I think the forex risk management practice resembles physical fitness. Everyone knows it is very important, but very few people do anything at all about it. Among those who hedge, few do it regularly, and fewer still do it scientifically.

The forex hedging landscape today is what the fitness industry scenario was 25-30 years ago, which is actually heartening. More people are aware of the need for physical fitness today than they were several years ago. Professionals keep sharing suggestions on diet, nutrition and fitness plans through newspaper articles. This encourages people to be more careful about their diet and to take up some sort of fitness regimen. Like people have become more health conscious over time, with more forex professionals writing about hedging, companies will certainly become more hedging conscious over time.

It was not always like this

However, it was not like this some 25-30 years ago. Fitness was equated with body building, which only wrestlers, boxers and some Hindi movie villains spent time on. This is akin to people equating forex hedging with only trading and speculation. Hindi movie heroes were generally not into fitness at all (remember Rishi Kapoor’s paunchy look in the 1990s and Sanjeev Kumar’s tyres in the 1980s?). Why, even cricketers were prone to muscle pulls and injuries all the time due to lack of fitness.

Thankfully, the fitness movement is a real thing today. Not only athletes and movie stars, but even corporate executives at all levels and across age and gender are taking greater care of their bodies, following the personal examples being set by corporate captains such as Rajiv Bajaj, Harsh Mariwala, Anand Mahindra and many others. Some are even pursuing serious running, cycling, some sports or the elusive six-pack abs, which is of the order of running serious derivatives programmes in forex. The daily fitness walk is more like basic hedging using Forward Contracts.

Today’s encouraging fitness landscape took a long time to build, with years of hard work by the likes of Mickey Mehta, Milind Soman, Rujuta Diwekar and several other fitness gurus, nutritionists, yoga veterans such as BKS Iyengar and Baba Ramdev, and legions of unknown daily practitioners who formed the bedrock of the fitness movement.

Coming to forex hedging, In its early days, post the 1991 Rupee devaluation and the introduction of LERMS in 1993, forex “hedging” was mostly about trading in forex by large companies and diamond merchants, which lasted till about 2000. Then came the Dollar-borrowing binge which ran from 2000 to 2008, during which companies threw all caution to winds egged on by bonus hungry bankers, finally resulting in the massive derivatives disaster of 2008, after which forex hedging virtually became a bad word.

Through all this, pioneers like Mr. AV Rajwade, Mr. Jamal Mecklai, ourselves and many others have been talking about forex hedging for more than 25 years now. Reliable forex forecasting (with the 73% Reliability of Kshitij forecasts) and systematic, scientific hedging (the KSHITIJ Hedging Method  ) came into being from 2006 onwards, helping companies deal with increased Rupee volatility. Slowly, very slowly, more and more companies are at least starting to listen to forex advisors more seriously. There is still a long way to go, but the outlook is encouraging.

Prevention, rather than cure

The pursuit of fitness and well being is rooted in the maxim of “Prevention is better than cure” and is entirely different from going to a doctor in case of illness. People go to a doctor out of compulsion, usually when a lot of damage is already done. At that time, the doctor’s medicines can, at best, prevent the untoward and unfortunate, but cannot make the patient healthy and fit. Similarly, taking a hedge at a time of extreme volatility, out of compulsion, can at best prevent some forex losses, but cannot make the company risk tolerant.

Just as, at its worst, lack of fitness can show up in debilitating illness with ruinous costs, lack of forex hedging can cause severe balance sheet damages. That is why, those who have understood the vital importance of fitness pick up a fitness regimen out of choice and those who view forex risk management as a vital part of business, take up the practice of forex hedging on a regular basis, even if it is with simple forward contracts.

Benefits of FX Risk Management

The first benefit of a well thought out hedging policy, implemented properly, is that it makes a company more risk tolerant and enables it to handle volatility much more calmly and with least damage. This is similar to the increasing immunity levels through a regularly fitness regimen, which enables us to ride over normal illnesses like the cold, cough and common flu with relative ease.

Secondly, just as fitness reduces lethargy, makes us more energetic and enhances our daily performance levels, a proper focus on forex risk management brings greater efficiencies into a company’s day to day functioning. How? The data and information flow, planning, focus on the future, execution and the co-ordination and communication between various departments of the company that is necessary for proper forex risk management, all together add up to yield greater efficiencies.

It is easy to see that companies practicing proper forex risk management are likely to be more efficient in their businesses, even deriving a competitive advantage out of it, than those who either do not hedge at all or hedge off and on or even haphazardly.

Never too late to start

Most people tend to give up on sports and fitness once they start their working lives, largely due to lack of time. They take up fitness again when they either find the luxury of time after their initial years of struggle or they are hit by some illness or due to both reasons. Still, whenever they start on fitness, it is never too late to start.

Similarly, most companies, especially SMEs who find themselves dealing with issues of production, sales, garnering of finances and scaling up, tend to neglect forex risk management due to lack of bandwidth. They either start looking at forex when other parts of their operations have stabilized or when they are adversely hit by volatility, or due to both.

By the same token, whenever a company starts to get serious about forex hedging is good. It is never too late to start. The important thing is to take up forex hedging seriously.

If you are into fitness and into forex hedging and this has got you interested, you might want to follow the Kshitij Rupee forecasts (which have a reliability of 73 on 100) and read more on forex risk management concepts.

Very frankly, as forex advisors, the onus lies on us to win the respect of our clients. This piece of thought is for ourselves at Kshitij.com as well as for our peers in the forex advisory space.

Here is a common enough scenario across all forex advisors – the advisor does a lot of studies, comes up with a forecast, devises a hedging strategy and dishes it out to his client. The client takes it gingerly, makes a herculean effort not to wrinkle his nose at it and then when he thinks the advisor is not looking, quietly consigns the advice to the garbage bin near his foot. And later, when the market moves in the manner predicted, it is the turn of the advisor to make a herculean effort to avoid saying, “I told you so!”

Ever wondered why corporate hedgers tend not to heed the words of their forex advisors? Well, there is a reason for it, rooted in human psychology.

The thing is, all of us human beings – clients and advisors alike, contrary to the assumption in economic theory, are emotional creatures and not the emotionless rational beings we are assumed to be. We are less like Mr Spock and more like Captain Kirk of Star Trek. This fact leads to many unanticipated consequences, which need to be accepted as the normal, rather than the abnormal. The whole new field of Behavioural Economics deals with this, and it is here that we find the answer to why clients do not listen to their forex advisors.

Dr Daniel Kahneman, the 2002 Economics Nobel laureate and one of the leading lights of Behavioural Economics, in his seminal book “Thinking Fast and Slow” has said that we human beings tend to overestimate the chances of those things which in actuality have very low probability. For instance, those things which have only a 1-2% statistical chance of occurring are estimated has having 6-8% chance in the human brain. Conversely, we also tend to underestimate the chances of those things which in actuality have very high probability. For example, something with a 98-95% statistical probability is humanly estimated as having a 87-79% chance of happening.

Why is this important to us and to this topic? It is seen that something which has a 60% statistical chance of occurring is underestimated by clients at 48% and something with a 70% chance is discounted to 54%. This means that if the suggestion of a forex advisor has 60% chance of being correct, in their minds, clients assume it to be 50%. And this is why they tend not to follow the advice as often as follow it. If the statistical chance of the advice being correct is 70%, it is discounted to 54% (a whopping 16 percentage points lower) in the client’s mind. It is at 70% Reliability that there is some hope that the clients may follow the advice a little more often. And, it is at 80% reliability that clients are likely to follow the advice 60% of the times! In other words, if forex advisors want clients to follow their advice most of the times, they need to exhibit a reliability of 80%.

It is not that corporate clients are a species from a different planet. Is not common that all of us follow the doctors’ advice no more than 50-60% of the times? Do we not discount the well meaning advice of our friends? Why, husbands are notorious for not listening to their wives (who are right even when they are wrong)! It is just the way the human brain is wired. We tend to make larger than necessary concession for the chance that our advisors may be wrong. In plain simple language, we don’t want to be caught on the wrong foot because of our advisor’s mistake!

Furthermore, when the corporate client does not even know the statistical track record of a forex advisor (other than experiential anecdotal knowledge maybe), how is he expected to place any faith at all in the advice? More ironically, when the forex advisor sanctimoniously says, “We are not in the business of forecasting currency movements, we are in the business of managing risk”, where does that leave the hapless importer/ exporter? He jolly well needs to know where the market is going, because how do you determine risk without having an idea of where the market is going, dammit!

We, at Kshitij.com started publishing a track record of the reliability of our Dollar-Rupee forecasts in 2006. We were probably the first and are probably still the only ones to do so. Since there was no model available, we devised our own criteria. As per that, our Dollar-Rupee forecasts have a 78% reliability over the last 13 years. That is like a career batting average. But, we found the criteria to be a little loose and relaxed. So we tightened the criteria. As per this second (and tighter) set of criteria, we currently have a 72% reliability. However, not satisfied with that either, we have now tightened the criteria even further and we find we stand at 60% reliability. Talk about making life difficult for ourselves!

However, unless we make life difficult for ourselves, how can we make it easier for our Clients? Unless we raise the bar on our own currency forecasts, how can we help our clients manage their forex risk better? Unless the fitness instructor himself does not have a six-pack, or cannot jog for one hour, how is he going to win respect from Hrithick Roshan?

We believe the ability to forecast currency movements is the first thing expected from forex advisors and we are on a mission to get better at it. We had a reliability of only 35% in 2008 and now we are 72% or 60% reliability (depending on the criteria used). We owe it to our clients to get it up to 80%. We are working on it. Maybe we will get there. We see it as a human challenge and that is why Kshitij.com forecasts currencies in the first place!

Now, here’s another very important fact about human psychology. Human beings might be irrational, they might be emotional. But, in the end people are not unreasonable and they do have a heart. Clients do ultimately appreciate honest, undying effort. In this, we are happy to share that over time, slowly, as our forecasts have improved, our clients are listening more to us. And are thus benefiting more.

Performance measurement can be a huge “let us take it to the next level” movement for the forex advisory practice, because, ultimately, let’s face it, the onus lies on us.

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