Monday 14 July 2003

Risk Management - in Business as in Polictics

Maltastar 

Risk management is nowadays a central part of business strategy. The speed of change has gone beyond anybody’s control. Experts are better at explaining why their forecasts did not materialise rather than in making accurate predictions about the future. And as the future is uncertain for all it is necessary for survival, let alone prosperity, to hedge risks.

Risks can never be totally eliminated, at least not at a commercially feasible cost, and therefore they are best managed. Take for example a portfolio invested for three years in the NASDAQ. The investor holds a view that over the next three years the economy will pick up and technology stocks will re-discover their sparkle. But he cannot be sure about it and there is the possibility that things will work quite differently. If this happens, when in three year’s time he has to cash out his investment, NASDAQ could be lower, much lower than its present level.

The investor has a choice. Either run the risk or manage the risk. If he runs the risk the maximum potential loss is 100% of his capital. If he manages the risk he could reduce this to a few percentage points. He could do so by buying an option to sell NASDAQ three years hence at today’s level. If NASDAQ shoots up the option is worth nothing and would expire without any value but the investor is happy because he would have made money on his investment from which profit he could afford the premium for the useless option. If NASDAQ boobs the option gains value. The more NASDAQ falls, the more value it gains mitigating any capital loss which would be incurred on the original investment. So for payment of a small premium to buy an option the risk of 100% loss is reduced to a few percentage points being the cost of the sell option without sacrificing the potential profit if NASDAQ performs as expected.

These risk management strategies in business are found in various forms. Even insurance cover is in itself a risk management tool especially if it extends beyond material damage to business interruption and professional liability. Foreign currency forward cover and options, interest rates swaps and options, future contracts for supplies of commodities, are all nowadays common financial tools to devise a proper risk management strategy.

The personal investor does not commonly use such strategies because the personal investor need not have a particular date when to cash the investment. It is quite normal for the personal investor to risk manage his investments primarily through diversification and secondly by staying invested as long as it takes for the investment cycle to turn to permit an exit at the top rather than through a take-it-as-it-comes exit strategy on a fixed date.

How does all this apply to politics? In politics the exit date, the judgement date, the day of reckoning is pretty well defined. It is the day of the general elections. Political parties work for five whole years devising policies, adopting media strategies, working out election campaigns tactics and so much more effort all pointed on the hope that on election day the majority of the electorate will back the party to gain government. A party that remains permanently in opposition even if commanding the following of a very large minority, is missing its objective and risking its existence. Let there be no doubt about this. Only through government can a political party reach its political objectives.

In politics the future is also uncertain. One adopts certain policies hoping that they gradually command majority following so that on Election Day the scales will tip in the party’s favour, but one cannot be too sure. In a political system where, by and large, the winner takes all, the losing party would be risking losing 100% of its political capital for the next 5 years. In the present context another 5 years for Labour could risk its existence. So next election presents far more risks for Labour than for the PN.

Are there any risk management tools that can help reduce, if not eliminate such risk for Labour regarding the general elections next due in 2008? The policies adopted are in themselves risk management tools. There are high risk policies and low risk policies. Totally risk-free policies have yet to be invented, unfortunately.

Labour seems to be building its strategy for next election on the premise that reality inside the EU will be a fountain of credibility for Labour and with the EU issue out of the way success is therefore practically guaranteed.

There is ambivalence in this position. While standing by the past, the future constrains Labour to adopt new policies of which it was severely critical in the past, even in allaharesqatt terms.

There is also the question that in politics perception is reality. The argument that if we always say the truth ultimately we will go to heaven has merits in religion. But politics is different. What matters is perception. As Tom Peters states in his In Search of Excellence in business, and I say as in politics, perception is reality.

So without ruling out that Labour policy stance could work out, it is certainly not without its risks, grave risks given the absolute need for survival for Labour to win next elections. I need not recall that if we miss next election we would condemn ourselves to more than a quarter century out of office given that the election after the next one will be due in 2013, well 26 years since we lost government in 1987.

Should Labour consider other risk managed solutions or should it risk it all on the premise that
Malta’s experience inside the EU will prove to the electorate that we were right and they were wrong?


Portfolio

Strategy 1 No Risk Lm1004.423
Strategy 2 Medium Risk Lm 1002.160 (after Lm40 charges)
Strategy 3 High Risk Lm Lm 969.110 (after Lm20 charges)
Strategy 4 High Risk For Currency . Lm 1017.210 (after Lm40charges)

All prices and rates of exchange are the latest available on Saturday 12th July.

Strategy 4, being the most the most aggressive one, moved sharply ahead during the week propelled by revived equity markets and strength of the USD and Yen on the foreign exchange markets. Similarly Strategy 2 registered progress but more limitedly given its medium risk profile.

Strategy 3 retreated as Maltacom dropped 1c0 on the local exchange although I still think that this strategy could perform better in the autumn months.

No changes were effected to the portfolios.

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