By Ade Fashola
I left United States Insurance and Securities market during the era of the 44th – President Barack Obama. During that period, being a registered representative was a big deal. The Examinations and the Conduct were thorough. The rules of engagement were complicated. Reporting every transaction and your income, separating client’s funds from returns and your income, keeping up with these rules in addition to shuttling between New York and Lagos was overwhelming. I therefore respected myself by stepping aside. Since then, I have restricted my role to shadow adviser to some of my ex-colleagues. In those days, I always advised my colleagues in the industry about avoiding hedging against incumbent, so we hedged every eight years.
The 44th president was heavily hedged against during his first (2008) and second (2012) term elections. The first tenure, due to his being an African-American against Senator John McCain who was a war veteran. Americans love their Military and serving in the military gives you priority services most of the time including within white-collar industry. During the second term, it was similar because he was running against one of the few beloved rich republicans, Mitt Romney a republican from Massachusetts now a senator from Utah. A lot of people lost on hedging heavily because President Barack Obama won the presidency both times.
I have a good friend that lost twice both in 2008 and 2012. He went into serious negative of about $307m. This is a big deal in the United States securities market especially if your book is heavily skewed towards clientele of 60 plus of age. I got it right both times not because I was using any reliable parameters but for my faith in the American Democracy and sentiment towards motherland and skin. Go too far left, they will bring you back. Move too far right, they will bring you back. This is a contrast to Nigerian politics and Nigerians that will keep doing the same thing over and over yet expect a different result. In the United States, if your report card is ‘failing” or majority view it as “failing”, you will be fired. No question about it. You must have a record to sell to get the votes, not “Baba Sope” (God-Father said). So, when my friend called me to come to the United States to help in hedging against this immediate past United States presidential election and I informed my team in Nigeria, one of the many questions was “What is hedging and what is its relationship to insurance”? This question has led me to this topic.
The concept of hedging is to transfer the risk to the speculator through the purchase of future contracts while insurance is paying premium in payment of a given sum in case of occurrence of insured risk. Insurance and Hedging are both transfers of risk. Insurance and hedging are taken specifically to reduce your exposure to financial risk, but they do so in different ways. Insurance typically involves paying someone else (insurance company) an amount called premium to bear risk and pay them an agreed amount (sum assured) in case of the occurrence of any of the insured perils. Hedging on the other hand involves making an investment in anticipation of a particular occurrence with the hope that the return from this investment will offset risk or any negative impact of the occurrence.
Insurance contract is buying an insurance policy that protects your home against fire does not guarantee that your home will not burn down. Having auto insurance does not mean you will not have a car crash, and life insurance will not keep you from dying. What insurance does is that it shifts potential financial losses from you to someone else. If your house burns down or your car gets into an accident or totaled, you do not have to pay to repair or replace it because the insurance company will do that. Hedging reduces exposure or uncertainty, which is really just another word for risk. A simple example would be to say you do a lot of business in the United States, and in analyzing your business risk, it is glaring you carry an exchange risk meaning that you will lose money if the exchange rate rises above N500 per dollar depending on who actually won the election. You can mitigate this risk by buying a series of options, contracts that give you the right to buy dollar for, say N400 per dollar. Those options offset your risk from rising exchange rates. If the rate never rises above N400, then you just let the options expire. But if the rate rises above N400, then you’ve locked in an exchange rate that offsets the increase and protects your profit. The options, therefore, are hedges. Both insurance and hedges cost money, premiums in the case of insurance, and the price of the options in the hedging example. But those costs are less than the losses you are protecting yourself against. That’s why the expense is considered worthwhile.
How do you hedge in a presidential election? Usually there are two political parties in the United States. There are a few others like the Tea and Independent parties. American politics are policies based. Each parties’ policies affect every person, companies and industry differently. Democrats are left wingers and Republicans are the right wingers. You have to determine what are the issues bothering the citizenry at any particular time that may determine the election, then know which industry/companies will the election affect if either of the parties wins and you decide to go very bullish on those policies sway company such that in case it happens, you hit a jackpot and if it goes the other way, you may loose big or stay below par. Wall Street usually looks ahead of a new presidency to determine their trading strategy. Sometimes, you may have a dicey outcome in which the presidency and the majority in congress parties are different, in this situation policies are stuck or comprise of a bi-partisan or non-partisanship. Although initial gains may be short-lived because trading is about a particular moment. Hedging can be used for locking profit, enables traders to survive hard market periods, limits losses to a great extent.
To be continued.
Ade Fashola is the CEO of Universal Risk
