Theories on Risk Management
By: Jill J. Dunkel
Managing risk is more than looking into your crystal ball for feeder cattle and grain prices. There are many factors to consider and more than one way to do it. However without a risk management strategy, a venture into cattle feeding will likely be a brief one. Volatility has become the rule, not the exception.
Bank of America/Merrill Lynch in Amarillo, Texas, has a large cattle feeding customer base. W. Ashley Allen said part of his company’s risk management strategy as a bank is to encourage risk management via commodity trading. “You look at how much money it takes to play this game, the voliatility in the futures market with the funds and so forth, and it’s spooky. We don’t require it, but we enourage risk protection. Most all of our clients are either in a fully hedged program or a managed hedge program.”
James Herring, CEO of Friona Industries, said part of his risk management strategy is controlling costs of inputs, buying at lows in the market.
“There are about 13 commodities that have a large impact on our bottom line. We’ve watched those commodities on a cyclical and seasonal basis to take advance of the lows in those prices,” he said. “We have a trade room and dashboard with commodity prices. We watch those on a minute-by-minute basis during trading hours. We want to be strategic. We want to be tactical, and we want to make good decisions on all so the end product is profit for the company.”
Commodities that Friona monitors include all input variables, including feeder cattle, natural gas, diesel fuel, silage, sweet bran, distillers, etc.
As part of a risk management strategy, Allen said it’s important for your bank to have a full understanding of hedging and margin calls. “It can chew up enormous amounts of money when it goes against you. You want to make sure your banker understands that,” Allen said. “One of the questions I get asked a lot is what if you are fully hedged and have to make margin calls.”
He said as long as his customers are hedged appropriately, he will back those calls. Brent Manwarren handles risk management for Poky Feeders and their customers. He said making margin calls can get discouraging, and that’s one reason that he offers to handle all risk management to Poky customers. “One of the biggest benefits to us doing the risk management for somebody else is how does it feel when you get those margin calls? When you are sending $1,000 checks off to Chicago day after day, you eventually get tired of it and think you’ve entered a bad transaction. And inevitably when you make that decision to pull out, it seems to be the market top.”
However, he encouraged cattle feeders to take the emotion out of sending money to Chicago and know if the cattle are bought appropriately and the feedyard does a good job feeding, there is a return on your capital.
It’s also important to decide if hedging is the best option or if other risk management strategies are more beneficial.
“Our philosophy is you’ll never go broke making a profit. You can go broke hedging a break even if you do it long enough and get a bad winter or something. What I’m seeing more of now is option-type strategies,” Manwarren said.
Strategies vary, but with the volatility in markets and political climates, Herring said more attention must be paid to the aspects of the production process that, in the past, cattle feeders have not had to worry about.