Connect with us

Business

Managing liquidity risk during a pandemic

Published

on

Managing liquidity risk during a pandemic

By Jeff Mount, CEO and Mike Helgesen, Director of Development of Real Intelligence LLC. 

The world seemed to be so much simpler just a few months ago.  Nobody wore masks to protect themselves and others from a potentially lethal virus.  There were no shortages in the aisles of grocery stores.  Unemployment was at historic lows.  Investing seemed relatively easy.

This financial crisis is different than just about every other we have faced due to the complete reversal of the simple life we enjoyed just a couple months ago.  The stock market has recovered somewhat due to the “hope” that our lives will return to normal in the coming days.  Investors have been so optimistic that they have clearly ignored the catastrophic unemployment claims of the last few weeks and are overlooking what are expected to be dismal earnings reports for the second quarter.  In the last six weeks, investors have driven the S&P 500 up 30% from the bottom in late March. This rapid rise—driven by hope and optimism—could be at risk should the pandemic spike again as people around the world attempt to restart their lives.  So, what is an investor expected to do to manage risk and create liquidity for upcoming life events (college tuition, weddings, etc.)?

Traditional financial planning is based on an institutional method.  It asks the investor questions that assess their risk profile and creates an allocation from which growth occurs during the accumulation phase and distributions occur when income is needed.  This allocation is reset on a systematic basis (semi-annually or annually) to take advantage of selling securities that are overvalued and buying ones that are undervalued.  Here is the problem with this—institutions do not get sick or hurt.  They do not get laid off.  They do not pay for their children’s tuition or weddings.  All of these real-life challenges require liquidity.  The most liquid security is cash.  However, cash pays the investor nothing and, therefore, creates a drag on a portfolio.  Bonds function as an instrument that offers less volatility than stocks (which makes them a great instrument to lower overall risk) and they generate income.  However, bonds endure two risks that should be addressed in this environment:  credit risk and interest rate risk.  It is unlikely that we will see the Federal Reserve tighten interest rates for a while, however, rates could potentially rise naturally if inflation becomes a concern due to lack of supply and/or continued supply chain disruptions. Credit risk, however, is a very real risk moving forward.  We just exited the strongest economy we have ever seen in the United States and the consequence of that is there are a lot of outstanding loans that were made to entities that will probably not survive this downturn.  These entities were probably in financial trouble before the downturn but were kept afloat by the strong market and easy access to more capital.  As the tide rolls out, it will be revealing to see who is wearing a bathing suit and who is not!  As sophisticated bond investors evaluate these bonds, they have to try to identify which companies have that healthy mix of strong revenues, a strong cash position, and enough of a dividend to justify the risk for the investor.  All of these challenges highlight why the traditional “institutional” method of financial planning cannot be trusted moving forward.

A new, more human-centered, financial planning method is taking shape.  It is called Dynamic Mapping, and it creates liquidity for the investor by applying a process called “aging of portfolios.”  Rather than putting the investor through the risk profile questionnaire experience (imagine how different the answers to these questions would be when asked last year versus today) and rebalancing back to an allocation that was probably flawed to begin with, Dynamic Mapping suggests creating purpose-based portfolios that each have their own unique distribution date.  Assets would be allocated very highly towards risky asset classes (like stocks) when the distribution date is far into the future (like 15 years or more).  As the distribution date nears, these portfolios gradually move to bonds, and then to short-term US Treasuries at the point nearest the distribution date.  Some compare this process to target-date management, but it is very different in that Dynamic Mapping assigns no downside risk management benefit to diversification of sub-asset classes.  Periods like a dotcom collapse, a global credit crisis or a global pandemic cause these sub-asset classes to correlate to “1”, thus eliminating the risk management benefit at the worst possible time.  Dynamic Mapping also strongly encourages the creation of a bear market reserve, a contingency reserve, and an inflation reserve.  Each is funded with different types of securities that provide liquidity for each purpose.  The bear market reserve and contingency reserve are invested in short-term U.S. Treasuries and the inflation reserve is invested in asset classes like TIPS (Treasury Inflation Protected Securities), commodities and dividend paying stocks.  Under all circumstances, investors who use this process will always have liquidity for those purpose-based accounts at the time they need it.

Once a financial planning method has been chosen and crafted, the investment management challenges begin!  It is a given that managing stocks for the short-term will be very tough.  The stock market makes enormous moves up when hopeful information is disseminated to the general public about the possible end to this crisis and equally powerful moves downward when the public is disappointed about economic data or a potential resurgence of the pandemic in the future.  Interest rate cuts and demand for safe assets have driven yields to near “0.”  If an investor wants to own a bond with a higher yield, they take on potentially devastating credit risk with companies who might default on their debt.  This dynamic certainly suggests a need for professional management of both stocks and bonds over passive strategies like indexing.  However, there is a risk of illiquidity in bonds when the bonds are inside of a mutual fund or exchange traded fund.  Here’s how this plays out:

  1. The bond fund manager builds a portfolio that meets the objective of generating income while managing credit risk through the diversification of investment grade and high yield bonds. (Without the high yield bonds, there is very little yield available to make the return performance compelling at this moment in time.)
  2. A cash position is created that is larger than the normal 3% in order to distribute to potentially exiting investors in the next downturn. However, it is almost never large enough to meet this objective because a large cash position creates an enormous drag on performance.  (Portfolio managers often receive performance-based compensation relative to their peers which serves as a conflict of interest).
  3. When the liquidity crisis hits, exiting investors burn through the cash and the portfolio manager is forced to sell bonds. The sale of these bonds in a crisis means the bonds will be sold at a discount and may take a while to clear (bonds do not trade on an exchange like stocks do).
  4. Since there will be no appetite for risk in the crisis, the portfolio manager will only be able to sell the highest quality bonds. Nobody will want to buy the high yield bonds that carry enormous default risk.
  5. The end result is that the exiting investors get their cash while the investors who were asked to “remain calm, all is well” (visualize Kevin Bacon in Animal House here)are left with a lower quality bond mutual fund than the one they initially bought and feel the pain of those bonds that were sold at large discounts. The risk of default in their portfolio would be higher than ever before.

Ideally, an investor would be better off hiring a portfolio manager to manage individual bonds they would own outright.  This would relieve the portfolio of any pressure from exiting investors and allow the investor and manager to remain patient during a liquidity crisis.

Another important risk management tool that is implemented in the Dynamic Mapping method is the calculation of purpose-based liabilities.  When saving for our children’s college tuition plan in the future, we often calculate the four-year tuition into the future with an assumed rate of inflation.  We rarely do that with retirement or other funding needs.  Dynamic Mapping calculates the personal liability for each of life’s purposes so that the investor knows exactly what amount they need.  These liabilities are graphed alongside their corresponding assets.  The output of the calculations is easy to read due to the graphical nature of the method.  No boring spreadsheets and no old school bar charts. For those who like to “do it themselves,” a free app called Dynamic Map is a calculator that can show these graphs.

The COVID-19 crisis has changed the world in many ways forever.  One of these changes needs to be the elimination of risk management methods that have nothing to do with the challenges faced by real people.  The old school method of financial planning is fine for foundations, endowments, and pensions.  No amount of “Monte Carlo analysis,” or other such gimmicks, will justify a “set it and forget it” asset allocation program designed to cover a family’s entire life.

Business

Oil prices steady as lockdowns curb U.S. stimulus optimism

Published

on

Oil prices steady as lockdowns curb U.S. stimulus optimism 1

By Noah Browning

LONDON (Reuters) – Oil prices were steady on Monday as support from U.S. stimulus plans and jitters about supplies competed with worries about demand due to renewed lockdowns to prevent the coronavirus from spreading.

Brent crude futures for March rose 7 cents, or 0.1%, to $55.48 a barrel by 1210 GMT. U.S. West Texas Intermediate crude for March was up 5 cents, or 0.1%, at $52.32.

“Sentiment was buoyed by expectations for a blockbuster coronavirus relief package … (but) the tug of war between stimulus optimism and virus woes is set to continue,” said Stephen Brennock of broker PVM.

U.S. lawmakers are set to lock horns over the size of a $1.9 trillion pandemic relief package proposed by new President Joe Biden, financial stimulus that would support the economy and fuel demand.

European nations, major consumers, have imposed tough restrictions to halt the spread of the virus, while China reported a rise in new COVID-19 cases, casting a pall over demand prospects in the world’s largest energy consumer.

Barclays raised its 2021 oil price forecasts, but said rising cases in China could contribute to near-term pullbacks.

“Even though the pandemic is not yet slowing down, oil prices have good reasons to start the week with gains,” said Bjornar Tonhaugen from Rystad Energy.

Supply concerns have offered some support. Indonesia said its coast guard seized an Iranian-flagged tanker over suspected illegal fuel transfers, raising the prospect of more tensions in the oil-exporting Gulf.

“A development that always benefits prices is the market turbulence that conflicts create,” Tonhaugen added.

Libyan oil guards halted exports from several main ports in a pay dispute on Monday.

Output from Kazakhstan’s giant Tengiz field was disrupted by a power outage on Jan. 17.

(Editing by David Goodman and Edmund Blair)

Continue Reading

Business

Dollar steadies; euro hurt by vaccine delays and German business morale slump

Published

on

Dollar steadies; euro hurt by vaccine delays and German business morale slump 2

By Elizabeth Howcroft

LONDON (Reuters) – The dollar steadied, the euro slipped and riskier currencies remained strong on Monday, as currency markets were torn between optimism about U.S. stimulus plans, and the reality of slow vaccine rollout and the economic impact of lockdowns in Europe.

Market sentiment had turned more cautious at the end of last week as European economic data showed that lockdown restrictions to limit the spread of the virus hurt business activity, dragging stocks lower.

The safe-haven dollar declined gradually overnight, and riskier currencies strengthened. It then recovered some losses after European markets opened, and was at 90.224 against a basket of currencies at 1152 GMT, flat on the day.

On one hand, market sentiment is supported by hopes for President Joe Biden’s $1.9 trillion fiscal stimulus plans, as well as the expectation that central banks will continue to provide liquidity.

But, in Europe, the extent of the risk appetite was limited by a lack of progress in rolling out the COVID-19 vaccine as well the economic impact of lockdown measures.

German business morale slumped to a six-month low in January, surprising market participants who had expected the survey to show a rise.

“It’s very much a case of hopes for the future against the reality of the first quarter of this year which is going to still prove to be fairly troubled,” said Jeremy Stretch, head of G10 FX strategy at CIBC Capital Markets.

“For now at least, the optimism that we’re hoping for has been somewhat delayed and that has taken a little bit of steam out of the euro and just put a little bit of support back in the dollar but ultimately I think it is still a case of those high-beta commodity currencies, reflation currencies, will continue to perform well,” he said.

Analysts expect a broad dollar decline during 2021. The net speculative short position on the dollar grew to its largest in ten years in the week to Jan. 19, according to weekly futures data from CFTC released on Friday.

The U.S. Federal Reserve meets on Wednesday and Fed Chair Jerome Powell is expected to signal that he has no plans to wind back the Fed’s massive stimulus any time soon – news which could push the dollar down further.

“The process of tapering QE is likely to be a gradual process which could last throughout 2022, and then potentially be followed by the first rate hikes later in 2023,” wrote MUFG currency analyst Lee Hardman.

“In these circumstances, we continue to believe that it is premature to expect the US dollar to rebound now in anticipation of policy tightening ahead, and still see scope for further weakness this year,” he said.

The euro was down around 0.1% against the dollar, at $1.2153 at 1207 GMT. At the European Central Bank meeting last week, President Christine Lagarde said the bank was closely watching the euro. The euro surged 9% last year versus the dollar and reached new two and a half year highs earlier in January.

But despite this verbal intervention, traders remain bullish on the euro, expecting the bar for a rate cut to be high.

Elsewhere, the Australian dollar, which is seen as a liquid proxy for risk, was up 0.2% at 0.7726 versus the U.S. dollar at 1208 GMT.

The New Zealand dollar was up 0.5%, while the commodity-driven Norwegian crown was up 0.2% the euro.

The safe-haven Japanese yen was flat on the day at 103.815 versus the U.S. dollar.

Graphic: USD, https://fingfx.thomsonreuters.com/gfx/mkt/qmypmyjdxpr/USD.png

(Reporting by Elizabeth Howcroft, editing by Ed Osmond and Chizu Nomiyama)

Continue Reading

Business

Hong Kong’s Cathay Pacific warns of capacity cuts, higher cash burn

Published

on

Hong Kong's Cathay Pacific warns of capacity cuts, higher cash burn 3

(Reuters) – Cathay Pacific Airways Ltd on Monday warned passenger capacity could be cut by about 60% and monthly cash burn may rise if Hong Kong installs new measures that require flight crew to quarantine for two weeks.

Hong Kong’s flagship carrier said the expected move will increase cash burn by about HK$300 million ($38.70 million) to HK$400 million per month, on top of current HK$1 billion to HK$1.5 billion levels.

Hong Kong is set to require flight crew entering the Asian financial hub for more than two hours to quarantine in a hotel for two weeks, the South China Morning Post reported last week, citing sources.

“The new measure will have a significant impact on our ability to service our passenger and cargo markets,” Cathay said in a statement, adding that expected curbs will also reduce its cargo capacity by 25%.

The airline, in an internal memo seen by Reuters, requested for volunteers among its crew who could fly for three weeks, followed by two weeks of quarantine and 14 days free of duty, adding it will be a temporary measure and not all its flight will require such an operation.

“We continue to engage with key stakeholders in the Hong Kong Government,” the memo said.

In an emailed response to Reuters, a Hong Kong government spokesperson said: “In the light of the evolving pandemic situation locally and internationally, the Government will keep reviewing and refining the arrangements applicable to different categories of exempted persons, including air crew, with reference to all relevant considerations.”

Separately, a company spokeswoman said the airline could not detail the impact on vaccine transport specifically in terms of cargo shipments.

The aviation industry has been hit hard by the COVID-19 pandemic as many countries imposed travel restrictions to contain its spread.

In December, Cathay’s passenger numbers fell by 98.7% compared to a year earlier, though cargo carriage was down by a smaller 32.3%.

(Reporting by Shriya Ramakrishnan in Bengaluru; Additional reporting by Jamie Freed in Sydney and Twinnie Siu in Hong Kong; Editing by Bernard Orr, Arun Koyyur and Mark Potter)

Continue Reading
Editorial & Advertiser disclosureOur website provides you with information, news, press releases, Opinion and advertorials on various financial products and services. This is not to be considered as financial advice and should be considered only for information purposes. We cannot guarantee the accuracy or applicability of any information provided with respect to your individual or personal circumstances. Please seek Professional advice from a qualified professional before making any financial decisions. We link to various third party websites, affiliate sales networks, and may link to our advertising partners websites. Though we are tied up with various advertising and affiliate networks, this does not affect our analysis or opinion. When you view or click on certain links available on our articles, our partners may compensate us for displaying the content to you, or make a purchase or fill a form. This will not incur any additional charges to you. To make things simpler for you to identity or distinguish sponsored articles or links, you may consider all articles or links hosted on our site as a partner endorsed link.

Call For Entries

Global Banking and Finance Review Awards Nominations 2021
2021 Awards now open. Click Here to Nominate

Latest Articles

Oil prices steady as lockdowns curb U.S. stimulus optimism 4 Oil prices steady as lockdowns curb U.S. stimulus optimism 5
Business3 hours ago

Oil prices steady as lockdowns curb U.S. stimulus optimism

By Noah Browning LONDON (Reuters) – Oil prices were steady on Monday as support from U.S. stimulus plans and jitters...

Dollar steadies; euro hurt by vaccine delays and German business morale slump 6 Dollar steadies; euro hurt by vaccine delays and German business morale slump 7
Business4 hours ago

Dollar steadies; euro hurt by vaccine delays and German business morale slump

By Elizabeth Howcroft LONDON (Reuters) – The dollar steadied, the euro slipped and riskier currencies remained strong on Monday, as...

Hong Kong's Cathay Pacific warns of capacity cuts, higher cash burn 8 Hong Kong's Cathay Pacific warns of capacity cuts, higher cash burn 9
Business4 hours ago

Hong Kong’s Cathay Pacific warns of capacity cuts, higher cash burn

(Reuters) – Cathay Pacific Airways Ltd on Monday warned passenger capacity could be cut by about 60% and monthly cash...

Stocks rise on recovery hopes 10 Stocks rise on recovery hopes 11
Business4 hours ago

Stocks rise on recovery hopes

By Ritvik Carvalho LONDON (Reuters) – Global shares rose to just shy of record highs, as optimism over a $1.9...

Fragile recovery seen in global labour market after huge 2020 losses - ILO 12 Fragile recovery seen in global labour market after huge 2020 losses - ILO 13
Business4 hours ago

Fragile recovery seen in global labour market after huge 2020 losses – ILO

By Stephanie Nebehay GENEVA (Reuters) – Some 8.8% of global working hours were lost last year due to the pandemic,...

"Lockdown fatigue" cited as UK shopper numbers rose 9% last week 14 "Lockdown fatigue" cited as UK shopper numbers rose 9% last week 15
Business4 hours ago

“Lockdown fatigue” cited as UK shopper numbers rose 9% last week

LONDON (Reuters) – The number of shoppers heading out to retail destinations across Britain rose by 9% last week from...

Alphabet's Verily bets on long-term payoff from virus-testing deals 16 Alphabet's Verily bets on long-term payoff from virus-testing deals 17
Business4 hours ago

Alphabet’s Verily bets on long-term payoff from virus-testing deals

By Paresh Dave OAKLAND, Calif. (Reuters) – For Alphabet Inc’s Verily, a healthcare venture that is one the tech giant’s...

ECB can price climate risk better than the market, Panetta says 18 ECB can price climate risk better than the market, Panetta says 19
Business4 hours ago

ECB can price climate risk better than the market, Panetta says

FRANKFURT (Reuters) – The European Central Bank can price climate risk better than market participants and should make its own...

Hong Kong's Cathay Pacific warns of capacity cuts, higher cash burn 20 Hong Kong's Cathay Pacific warns of capacity cuts, higher cash burn 21
Finance4 hours ago

Hong Kong’s Cathay Pacific warns of capacity cuts, higher cash burn

(Reuters) – Cathay Pacific Airways Ltd on Monday warned passenger capacity could be cut by about 60% and monthly cash...

Dr. Martens owners to raise $1.78 billion in London IPO 22 Dr. Martens owners to raise $1.78 billion in London IPO 23
Business5 hours ago

Dr. Martens owners to raise $1.78 billion in London IPO

By Abhinav Ramnarayan and Tanishaa Nadkar (Reuters) – The owners of Dr. Martens aim to raise close to 1.3 billion...

Newsletters with Secrets & Analysis. Subscribe Now