Many banks completely avoid foreign exchange risk. They borrow and lend in the same currency. Any customer trades are immediately offset. Bigger players use spot, forward and options markets. But an underlying theme of monitoring and managing exposures overrides. For small businesses things can be different. FX mismatches don’t always get priority. With the recent weakness in Sterling if you export and have unhedged currency earnings; happy days, not so for importers paying in FX. Many SMEs will take this on the chin – the decline in Sterling being just one of those risks you can’t do much about.  If that’s your view and you run some currency exposure it’s time to reconsider: What’s the size of that risk relative to your profitability? What would an adverse change in the FX rate mean for you? Can you pass the costs on to customers? Can you change your terms of trade? How do you price your goods and services? When you buy and sell FX could you get better rates elsewhere? Could you benefit from simple hedging? Why now? The Bank of England’s mandate is not the exchange rate. Decisions are targeting other economic variables. Unconventional monetary policy is experimental and the outcome is unknown. As a result the value of GBP will almost inevitably take some of the strain. This could be either up or down. Volatility aka risk has increased.

Back in 1997 Gordon Brown announced that the Bank of England would have freedom to control monetary policy. It was heralded as a move away from short term political interference towards a long term framework of prosperity. Does this need rethinking? In this country the elected government has two economic levers, fiscal and monetary policy. These are not entirely separate. Increased spending impacts on variables targeted by monetary policy and vice versa. However because of the 1997 decision the pricing of money has been left to experts who largely go unchallenged. What’s of concern is that “group think” appears to have set in and the answer lies in lower rates and more QE. This is academic and experimental policy. It has also been far from satisfactory in the real economy. For example: Lower rates have encouraged both private and public sector leverage; Asset prices have been inflated. In particular housing; Bank margins have been eroded at the same time banks need more capital; Pension scheme deficits have ballooned; Doing more for longer has increased uncertainty - bad for investment, productivity falls. Flat zero bound yield curves just aren’t the answer. Neither is further spending which is predicated on the assumption that government can invest at a ROC exceeding zero. What is required is that politicians start to engage and where necessary be critical of monetary policy. This is how democracy works. Otherwise we are leaving a major policy tool in the hands of experts without any real challenge and we all know where that can go.

Traders know that being long means when the market goes up or sideways they win. This forms the basis for carry trades. That’s winning two times out of three. The edge comes from the asset’s income exceeding the cost of financing. Short sellers have a harder time. The cost of borrowing can be hugely expensive. Timing is not a luxury they have. Timing is also in our minds when we think about central bank tightening. When will it happen and how rapid will it be? In the meantime zero and negative rates make sitting on the side lines similar to running short. But nearly eight years have elapsed so the compounded effect is painful. There is no simple answer but it's probably better to stop trying to guess the next policy move and accept that being invested is the only answer.  Albeit that at this point in the cycle your bias may prefer keeping leverage down and hope that time is on your side.

Just before the big vote few people expected the UK to opt out of the EU. If you believe that markets are, by and large efficient, the small risk of Brexit was priced in albeit with a low probability. However because of a yes/no decision the unexpected vote makes larger waves. Something traders call gamma risk. It’s a problem because it’s almost impossible to hedge. It also means that normal models (deltas, VaR etc) don’t fully describe your downside (or upside) potential. Political risk is something for which they aren’t designed. In a world of low growth, as capital and labour fights for a bigger slice of pie this risk is magnified. It’s therefore appropriate to ask how you capture it. The standard approach is scenario or stress testing. The problem is that often the picture painted isn’t one of political disruption. It’s more a “what-if” based on moderate volatility. A more instructive approach would be to consider why turmoil occurs and what it can do. Good places to start would be 19th November 1967, 18th October 1987, 16th September 1992 for longer periods consider 1987-1993. This will look ugly. But it helps you understand two things. What courses of action can you take? And Is your business balanced? If like me you think politics are back it’s a worthwhile exercise.

If you have tried any of the following you could be in for a nasty surprise. Things are not as smooth as advertised. Opening an account Moving money Altering an asset manager Changing details The list goes on…… With the aid of technology they should all be simple and seamless but you end up doing a lot of unpaid work for the provider and things can still go wrong. Once manual intervention is needed mistakes multiply. Big banks are particularly guilty. It’s where technology meets human intervention when things invariably go awry. When dealing with retail customers banks, in the rush to apply IT, seem to have forgotten that when things don’t work the fall back is email, phone and paper. Resolution requires some old fashioned skills. Unfortunately finding people who understand the issues rather than reading from a script isn’t easy. Furthermore getting action within an appropriate timescale is nigh on impossible. The worst part is that this wouldn’t have occurred three decades ago. These are problems of capital allocation. Why spend money on sorting things out if you can’t demonstrate a return? It’s simple. A business that loses customers by neglect needs to reconsider where it will be in the future.

What do the following two examples have in common? Example 1: If a 25-year-old saves £1,000 for retirement in 40 years’ time how much will they have? That depends on the rate of return. Using a 5% rate (realistic in current conditions) the amount is £7,040. A fund manager who charges 1% reduces this to £4,801. Factor dealing costs of an additional 1% and you have £3,262. In other words, you lose (7,040-3,262)/7,040 = 53.6% of your investment. Example 2: A customer pays 0.99% for a 2 year £70,000 mortgage with a fee of £1,499. Amortise the fee and the rate is (1,499/2)/70,000 = 1.07% higher or 2.06% The common theme? It’s how Joe Public gets side tracked or should I say "ripped-off". Whether this is a regulatory issue is a moot point. Suffice to say that retail facing financial services are under a fiduciary duty but also have a conflict of interest (profit). Therefore, unlike other industries they should be duty bound explain in simple terms how much they are taking out of the customer in terms that the customer can understand. It’s interesting to see that the teaser rate and fee model has been dropped by some banks. This is a step in the right direction. But a lot more could be done. In particular the funds industry needs to be open to showing dealing costs in the expense ratio. No one wants to see over half of their pension disappear in fees and commissions.

US bank stocks are indicating that the new administration may scale back the regulatory onslaught that followed 2008. Could this make Bank capital requirements less restrictive? It could. Other countries would need to follow suit or be at a competitive disadvantage. Whether you think this is good news depends on your views. On balance some rules have been helpful but regulation has become an industry that doesn’t add to productivity. If the regime is relaxed it could have important economic implications. Whilst quantitative easing has lowered interest rates the anticipated economic upturn has been very muted. After all before the crisis a 5% cut in rates would have led to a red hot economy. But if banks once again are free to expand their balance sheets it could turbo charge the current policy stance. Whether this happens depends on credit demand and banks’ risk appetite. If it does it's sure to be inflationary. The economies that would be most affected stand to be where banks do the most intermediation. That’s Europe…..Interesting times.

In this low rate environment pension liabilities have ballooned and companies have opted to close final salary schemes. Many private sector workers are therefore reliant on money purchase schemes. This means they save a proportion of their salary in a tax-free account ready for the day they retire. Handing this responsibility to individuals is in many respects good provided two things are present: First, have sufficient understanding to enables them to weigh-up what to do before they do it. Second, the institutions that they deal with don’t fleece them. Sadly, in the UK this isn’t the case. Many people do not seem to understand money - not even in the Micawber sense of cash in and cash out. The reason for this is it is not taught at an early age. And if you don’t understand the basics how are you supposed to deal with the firms that handle your investment. Do you end up losing your arms and legs? Could we improve this situation? You bet. Policy should: Bring money into the classroom and; Target public information (just like health).The market will also find an answer. For financial firms that offer value there are benefits. Witness how “passive” is now gaining in the US. Is this a market where the average consumer is better informed? Probably. It will happen here too.

Last week I was discussing liquidity and market risk with two different banks. On reflection, it’s apparent that the way we set risk appetite is inconsistent. For liquidity risk one of the key measures is the liquidity coverage ratio. The survival period is measured on a stressed basis. This is relatively severe and is backed up with chapter and verse from the regulator on how it’s done and what happens if you don’t do it properly. This risk has had the full treatment.  Consequently, banks hold much more liquidity than a decade ago. But there are still breaking points. Has market risk had the full nine yards too? No. We know that on a series of bad days you can lose a fortune so we add stress testing to gaps, deltas and vars. But does it go to the same extent as liquidity in battening down the hatches? I think not. It’s as if, encouraged by QE, market risk is the dog that didn’t bite. Inconsistencies like this can cost us dear. Have we overcooked “liquidity” and underdone “market”? If we have we are buying insurance for something we don’t need whilst taking on a risk for which we aren’t properly prepared.

Reinvestment of interest is the cornerstone of successful long term investment. Einstein recognised compounding as the eighth wonder of the world (“…he who understands it, earns it…he who doesn’t… pays it.”) The law of 72 shows that a return of 4.1% takes 18 years to double your money and a return of 1.60% takes 45 years. Incidentally these are the yields on Diageo and Long Gilts. (You pays you money and takes your choice). It’s a fact that long term assets that pay little or no return damage terminal value (retirement plans). “Modest” fees and commissions do the same. Pay fees and commissions of 1.5% on a portfolio yielding 4.1% and it takes 27 years to double your money. That’s 9 years more. Fund managers tell us not to worry. The key to performance is concentration. That’s what you’ve got to do. But something’s missing. What’s the appetite of the investor for risk? If it’s pension savings I bet it’s quite low – better a quiet old age not one shelf stacking. And herein is the problem. Why bet the house when you don’t need to? Some managers have a fantastic performance but what's the future? In the US investors asked this question and found no answer. Their safest bet - passive. If you don’t fancy stocking shelves but really must have a flutter don’t put all your money on one horse or for that matter one rider- It’s the bookies that win. Good luck on Saturday’s National!

According the FT on 27/4/17 local councils are borrowing from the Treasury at about 2.5% to fund real estate yielding around 8%. The net interest income being used to fund spending. The balance sheet of some councils now being dominated by this carry trade. On 2/5/17 The Times reported an investigation into the motor industry. Have PCP contracts been mis-sold? Credit cards have also come into the spotlight. Is new business being written at rates that will fail to cover future defaults? These things appear to be unconnected. But in truth they result from depressed interest rates. At this point in the economic cycle and without policy intervention rates would be 2%-4% higher. The resultant higher borrowing costs would deter additional marginal financing. Whilst rates are so low the normal questions about loan affordability are suspended. The longer this continues the bigger the eventual problem. Once rates head North defaults will rise. Mitigating action can be taken. Affordability tests and increased capital requirements slow down marginal lending. But “fine tuning” like this has never been that successful. Surely a better solution would be slightly higher rates now.

To be an equity investor (active or passive) you must be an optimist. You believe that the future will be better and with this income and growth will accrue.  The route may be bumpy but you know that if you are invested for two decades it’s almost impossible to lose money. This applies even before major sell offs like 1987. Why? Because economies grow and those in them get richer. If you have any doubts just compare today with the past.  We have more of just about everything. Earlier generations would be aghast at the way we now spend. On top of this the things we buy are better. (Think cars, T.V.s, computers etc, how we factor this into GDP is another story). But the trend is not continuous. Sometimes our financial well-being treads water, occasionally it goes backwards. But to be sure progress is inexorably Northwards. Would you rather be living today or fifty years ago? During this election campaign, several things have struck me which may go on to influence this trend. Much of the rhetoric wants us to believe that we are worse off today than were in the past. It also offers little hope of improvement in the future (a point I will come back to). The discussion of the country’s financial situation has been largely ignored. This at a time when, as an open economy, sound economics is essential to our future prosperity. There is disregard for business and “supply side” issues. Wealth creation seems a “dirty” concept. What’s to be missing? I call it Leadership. Surely any party that hopes to win must offer a vision of the future. A place where we are all doing better. It must convince voters that they can participate through hard work, effort and entrepreneurism. Robbing Peter to pay Paul is not the answer. What of the future? As an equity investor, I am optimistic. But I recognise that poor policy selection (of the type I am currently hearing) has the potential to harm. In other words, we will be better off but not by as much as we should be.