How can small business deal with today’s currency fluctuations?

Mal Spooner is a veteran fund manager and currently teaches at the Humber College School of Business.
Mal Spooner is a veteran fund manager and currently teaches at the Humber College School of Business.

Right now it’s no secret that selling merchandise to Americans is pretty lucrative.  We also know that it hasn’t always been this way.  A relative of mine who sells lighting products to customers the U.S. is a case in point.

My brother-in-law built a very successful business with his wife from the ground up.  Their decision to sell to markets in the US worked fine, but the real boost to sales occurred when their son joined the business and talked them into selling on the Internet.  Online sales boomed, but of course so did their company’s vulnerability to exchange rate risk.

A few years ago, he was struggling to make his usual margins (which are not that big at the best of times) when the CAD/USD exchange rate approached par.  In other words, a C$ was pretty much equal to the US$.  Cross-border shoppers from the Canadian side of the border were in heaven (myself included), whereas exporters were beginning to panic.  After all, their costs were still in Canadian dollars, which was an advantage when they received sales revenue in a much stronger $US.  Converting back into Canadian currency provided a substantial bonus to their profits and quality of life.

Things are great once again, but how can a smaller business owner(s) plan ahead to make sure that currency risk doesn’t threaten their livelihood?

The graph below illustrates the impact currency can have on a business.  Imagine a fictional Canadian company that began selling a specialty cheese to the U.S. marketplace in June of 2006. The sale price stays the same (due to competitive pressures) at US$ 2.50.  Costs are steady in C$ 1.98 range.  Sales made in US dollars must be converted back to Canadian dollars.  
USD-CAD sales and profits
It is easy to see how just the exchange rate can wreak havoc on a businesses revenues and profitability.  Is it possible to anticipate or prevent this volatility?  When companies are accustomed to very large orders, it is possible to contact your bank and make arrangements to use the currency forward markets in order to ‘hedge’ your profits.  For instance, if one expects to have to convert a significant amount of foreign currency into one’s domestic currency once the order is delivered, you can arrange to lock in the forward exchange rate today, thereby knowing exactly what your margin is (and will be).

However, the orders for most small businesses aren’t large enough to make hedging a viable option. Can you plan for currency fluctuations?  Experts agree that there is no robust way to forecast exchange rates.  Experts have been frustrated trying to predict exchange rates for years, and the forward markets/futures markets are not very good predictors of the exchange rate that will actually occur in 3 to six months.

One approach that has been around (seems like forever) is the purchasing power parity theory.  The price of a consumer product (same materials, can be sourced locally or at same prices) should be the same in different countries, once adjusting for the exchange rate.  Below, the table compares the price of the rather ubiquitous iPhone in Canada, Europe and Asia.  The price of the iPhone 6s 16GB (unlocked) in the U.S. is about $699, and should be more or less the same in Nanjing, China (their currency (is the remninbi or RMB) adjusting for the exchange rate as it is in Berlin Germany (euros).  As you can see from the table, this is not the case (the prices and exchange rates are not 100% accurate due to rounding).

iPhone intl pricing

Because Germans and the Chinese have to pay an even bigger price, it suggests the the USD is overvalued relative to those currencies.  The Canadian dollar on the other hand, based on this overly simple approach is actually still a bit overvalued compared to our neighbour to the south even at these depressed levels.  Of course, our proximity to the US might simply give Canadians a great deal on iPhones not available in other countries.

We should therefore expect the USD to depreciate relative to both the EUR and RMB in due course – the forces of supply and demand (for products, services and therefore currencies) should cause disparate prices to equilibrate.  The mobile device in theory should cost the same to the consumer no matter where he/she lives.  Should the USD decline significantly (perhaps even compared to the Canadian dollar) then the margin on good and services businesses in those countries are earning today with decline.

When sales are in another currency

The problem, is that historically purchasing power parity is also a poor predictor of exchange rates. The game of international finance is extremely complex.  Not only are exchange rates determined by differing interest rates in countries, balance of payments, trade balance, inflation rates and perceived country risks, the rates are also influenced by expectations associated with these variables and more.  The bottom line for smaller businesses is that when it comes to foreign exchange risk – they are completely exposed.

So what can be done?  Planning.  It is tempting to become overly optimistic when exchange rates have drifted in your favour, encouraging further investment to facilitate more sales in the stronger currency.  Buying equipment, hiring permanent labour and leasing more space introduces higher fixed costs that might dampen or destroy profitability when the tide turns the other way.  It is important to consider ‘what if’ scenarios frequently – and especially before laying out more capital. For entrepreneurs the biggest mistake is to take for granted that the status quo will continue.  All of a sudden, you might be buying yourself a bigger house, a fancier car and sending the kids to private school – all based on current income which is linked to the current prosperity of your business.

Currency instability is a fact of life, and the best way to be prepared is to expect the inevitable. Rather than rush to spend more on expanding the business put aside a ‘safety’ cushion during good times that can be drawn upon during bad times.  If your commitment to the US, European or other markets is firm, then park the cushion into currencies you are vulnerable too.  For example, invest your cushion in US dollar denominated assets – U.S. Treasury bills will provide a natural hedge for your sales.  Similarly, if a significant volume of your sales are in Europe and the company borrows funds for operations, borrow some funds in euros as a hedge – then if the euro appreciates you’re able to pay those obligations in the same stronger currency thanks you your euro receivables.

It is widely believed today that the USD is likely to depreciate relative to a number of other currencies, and perhaps imminently.  Today might indeed be the ideal time to begin considering ‘what if’ scenarios and the actions you can take to plan ahead.

 

 

Dodging the DOL Chainsaw: Small Business Owner Protection

The DOL is Coming!   The DOL is Coming!

As if you weren’t already up to your elbows in rules, regulations, and expenses, the Department of Labor has empowered itself to fine at least half of the Employer/Plan Sponsors it audits… for multiple investment related reasons.

These include, among other things, the cost of the products in your investment menu and the market value performance of those products. As a plan fiduciary (right, you are a plan fiduciary), it’s your job to keep costs below average and performance above average…. and, yes, you are deemed responsible for your employees private investment decisions… no matter how foolish.

Hardly seems fair, does it. You give them money to invest, and you’re too blame when they mess up.

But, true to form within the 401k “space”, no one (other than the plan participants) seems to care about the retirement income benefit that 401k plans should provide to employers and employees alike… not even the DOL, ERISA champions of the interests of employees.

Since roughly half the plans will always be below average, it’s fair to expect that large numbers of plans will be fined….

In fact, 70% of plans audited in 2013 were penalized or forced to make reimbursements. Neither ETF providers nor Mutual Fund promoters share this responsibility with you, and all of this stress is on top of the “top heavy” problems you deal with year, after year, after year…

You may be able to protect yourself from the fines and the “top heavy” audits in one fell swoop by switching your plan to a professionally-managed-by-a-fiduciary, self-directed 401k they call a “Safe Harbor” Plan. In this type of plan, there is no menu of one size fits all products, none of which focus on income purpose investments that support the ultimate benefit of the program.

You see, the goal of the providers is to keep your money in their funds forever, hoping for upward only markets and their ability to convince you that you just can’t do better than 2% income anywhere. That’s the 401k space “end game”, but you can do much better, and considerably safer in a… “Safe Harbor”, managed growth and income program…

In the self directed, private portfolio “space”, you can require the safest equity selections, and growing retirement income, in a flexible asset allocation geared to the age and risk profile of each participating employee. Employees don’t have to participate, but you have to provide an immediately vested matching contribution if they do…. BUT, the top heavy problems disappear, and your contribution levels have no backdated limitations.

Not so long ago, I brought a QDI (Quality, Diversification, and Income) portfolio series to the 401k space. None of the product pushers were even slightly interested in any facet of the program… not even the superior retirement income generation capabilities… the “good ‘ole boys club” just couldn’t be bothered.

With the stock market at the peak of a six year sustained rally, what protections do you have from a correction? In the managed programs I’m describing, equity profits have already been taken, and the income keeps growing… monthly, in most cases. The Target Date Funds 401k providers are in love with are low quality equity, seriously low income time bombs, ready to go… KABOOM!

The Vanguard 2015 Fund, for example, was 50% invested in no less than 5,000 stocks at the end of January 2015; the total portfolio income was just barely 2%. What do you think the 2020 or 2025 portfolio looks like?

Here’s a look at the workings of a professionally managed retirement income program: a high quality, individual security, 30% Equity portfolio, generating three times the Vanguard 2015 TDF income, with a whole lot less risk:

https://www.dropbox.com/s/28ty6z5dkgn5ulu/Retirement%20Income%20Webinar.wmv?dl=0

Hmmmm, Small Business Owners, seems to me that would resolve your fiduciary issues.

The “Retirement Ready” 401k… exists. Right?

Income Production = Market Value Growth + Retirement Security

Unfortunately, it just isn’t available to you in the standard 401k product menu.

Since the demise of corporate Defined Benefit Plans, most employees have been forced to rely on their own investment acumen to make sense of the product menu choices accompanying an ever growing array of private and public Defined Contribution Plans.

These are savings plans that use hundreds of pooled portfolios of securities and derivatives, many with suggestive and exotic names, to invest and reinvest participant and employer monthly contributions. It is rare that any unbiased advice is available to either Plan Sponsors or Participants, and even professional fiduciaries seem a bit brainwashed when one observes the results of their investment product choices.

Recently, it was proven to me fairly conclusively, that no product specializing in top tier  S & P dividend paying companies in combination with a diversified collection of Closed End Income Funds yielding over 6% (after expenses) will ever gain traction in the “good ‘ole big boys club” described as the 401k space.

Quality, meaningful diversification, and income production, the core curriculum of college investment majors for a century or more is now deemed to be an “Alternative Investment”. This a term once reserved for the most speculative of  speculations… futures, options, indices, shorts, commodities, junk bonds, emerging markets, etc.

The speculative essence of 401k Plan product menu choices, coupled with the utter disinterest in providing meaningful income choices (even toward the end of a TDF “glide path”), just screams for a better way for employers to get, 401k-like, tax deferral and wealth accumulation benefits.

For smaller employers, a 401k “safe harbor”, self-directed, program is an attractive alternative with none of the Wall Street program investment choice drawbacks…. AND no “top heavy” or annual recalculation aggravation. Yes, there must be a “match” for employee contributions, and immediate vesting, but a maximum contribution with total matching is a major plus.

Sure this can be done without the help of a professional manager, but that will just put  you back into the same stuff of the 401k model… no known quality, no income, and a taste of every available speculation the Wall Street imagination can devise.

An ideal self-directed program would provide for professional portfolio management with an ever increasing income “purpose” asset allocation “bucket”, based on the age of each participant. For Example:

Self Directed, individually and professionally managed, portfolios for all employees featuring:

  • flexible asset allocations (ranging from 60% Equity to 0% Equity)
  • annual income growth (in all* investment and interest rate markets)
  • annual Working Capital growth (so long as income, gains, & deposits exceed losses)
  • one-to-one convertibility to a Rollover IRA
  • “ROTH” 401k availability

*Using the 2008-2009 Financial Crisis as a worst case scenario.

Many of you have attended the current series of income investing webinars (the January program video is available through the link provided below). This is the kind of program that you could create inside your 401k Plan if it were to become the “Self Directed” variety described above… isn’t it time that you got the most out of your company’s retirement income program?

Remember, that since every investment program becomes a retirement income program eventually, you need to bring your program to a place where you can say with reasonable assurance:

“A stock market downturn will have no significant impact on my retirement income”

Only private “safe haven” type 401k plans, those that are both self directed and managed with the MCIM methodology appear capable of developing annually increasing spendable retirement income. The others just don’t seem to care.

“Retirement readiness” doesn’t just happen; there’s no button you can push. Those of you who are counting on a forever upward stock market, or the promise of a Target Date Fund need to “get real”, and quickly.

Here’s the content of the Vanguard 2015 TDF as of January 31, 2015:

Vanguard Total Stock Market Index Fund ………………..34.9% (3008 different stocks)
Vanguard Total International Stock Index Fund ……….15.1% (5008 different stocks)
Vanguard Total Bond Market II Index Fund ……………..32.4%
Vanguard Total International Bond Index Fund…………10.0%
Vanguard Short Term Inflation-Protected Index Fund…7.6%

Equity Total = 50% Income Total = 50% TOTAL PROGRAM YIELD = 2.01%

So, if your Million Dollar Retirement Portfolio is in this TDF, will you be able to survive on $1,675 per month?

Have a private look at the workings of a professionally managed retirement income program; a high quality, individual security, 30% Equity portfolio, generating a million dollar prorated, $5,480 per month:

https://www.dropbox.com/s/28ty6z5dkgn5ulu/Retirement%20Income%20Webinar.wmv?dl=0