The financial services industry is as adept as other professions in developing jargon. This is sometimes a useful and convenient way to express ideas succinctly between groups of busy peers. Too frequently, it is also a practice used liberally by practitioners in a bid to make them sound to the uninitiated as though they know what they are talking about - when often they do not.
Some of this jargon is deliberately designed to put a favourable 'spin' on something. The idea is that by changing the way a product, say, is described, it can induce positive thinking that may cloud an independent party's view of the facts.
Much of such practice is harmless enough. These days, we are used to hearing about 'high-yield' rather than 'sub-investment-grade' debt or - to put a negative connotation on it - 'junk'. But it becomes more sinister when terms like 'best-of' structures that promote an unfeasibly high headline coupon of, say, 40% are used in discussions with retail investors, when a simple back-test would show that investors will be lucky to receive much above 0% in returns.
The term 'over-hedging' appears to be an extreme example - it has been increasingly used in recent months to describe currency positions taken by Asian companies. 'Over-hedging' in volatile markets has apparently pushed many small private entitites into bankruptcy and forced Citic Pacific to reach for a large-scale bailout from its mainland parent.
A 'hedge' is 'a contract entered into or asset held as a protection against possible financial loss', according to The Oxford English Dictionary. And to hedge is to 'protect (an investor or investment) against loss by making compensating contracts or transactions'. So what is an 'over-hedge'? The Oxford English Dictionary doesn't appear to have a definition. That's because it is a term used by companies that want to take speculative positions in asset classes where they may have some direct exposure. But over-hedging has nothing to do with efforts to protect against financial loss - rather, it refers to outright bets on the markets.
There is nothing wrong with speculating - hedge funds and bank proprietary trading desks do so every day. But investors do not tend to buy into corporates for their financial derivatives trading capabilities. And investors should certainly be aware that a company is undertaking such activities.
Moreover, use of the term threatens to tarnish companies that deploy genuine 'hedges' that enable them to focus on the business area where they believe they have a competitive advantage. The term 'over-hedging' is a misnomer - and a dangerous one to boot.
More on Structured Products
Chris Leone and Dushyant Chadha replace Paul Galietto
Steffen Scheuble says growth in mainstream strategies may be nearing saturation point
Capital-at-risk product pays out early if crude index is no lower than strike price in 30 months’ time
Investors’ capital at risk if underlying is below barrier level at maturity
Sign up for Risk.net email alerts
Directional portfolios and limited diversification will hamper recovery process
Exchange plans to attract foreign money into India through enhanced technology
Systemically important status seen as business threat by asset managers
Recent Iosco consultation paper aims to better co-ordinate global regulation
There are no comments submitted yet. Do you have an interesting opinion? Then be the first to post a comment.