When it comes to managing investments in today’s unpredictable world, risk is everywhere. But while most Australians know about market risk or credit risk, there’s one less obvious threat that can quietly erode your returns: basis risk. In 2025, with local and global markets more intertwined than ever, understanding basis risk isn’t just for finance professionals—it’s essential knowledge for anyone who invests, hedges, or manages assets in Australia.
What is Basis Risk? More Than Just a Jargon
At its core, basis risk arises when there’s a mismatch between the price movements of two financial instruments that are supposed to move together. Most often, it pops up when you use a derivative (like a futures contract) to hedge an exposure, but the value of the hedge doesn’t perfectly offset the value of the underlying asset. The difference in their price changes—that’s the basis.
- Example: Suppose a wheat farmer in New South Wales uses ASX wheat futures to hedge the price risk of their crop. If the price of local wheat diverges from the price of the futures contract at settlement, the farmer faces basis risk. Even with a hedge, they’re exposed to the gap between the two prices.
- Real-world Impact: In 2025, Australian grain exporters have reported increased basis risk due to global supply chain disruptions, extreme weather events, and shifting demand patterns. The difference between local and international wheat prices has widened, making hedging less predictable and potentially costly.
Why is Basis Risk a Hot Topic in 2025?
Several factors have brought basis risk into sharper focus for Australian investors and businesses this year:
- Interest Rate Volatility: With the RBA’s ongoing adjustments to the cash rate to combat inflation, the spread between Australian government bond yields and interest rate swap rates has fluctuated more than usual. Fixed income investors hedging with swaps have seen unexpected gains or losses due to basis risk.
- Climate and Commodity Markets: 2025 has seen another round of El Niño-driven droughts impacting Eastern Australia. As a result, agricultural commodity prices have decoupled from global benchmarks, amplifying basis risk for farmers hedging with standard futures contracts.
- Financial Regulation Updates: The implementation of the new Australian Financial Markets Regulation Act 2025 has tightened reporting requirements for derivatives, but also highlighted the need for more robust risk management practices around basis risk, especially for super funds and managed investment schemes.
All of this means that both retail and institutional investors need to be more vigilant about basis risk than ever before.
How to Manage Basis Risk in Your Portfolio
While you can’t eliminate basis risk entirely, you can take practical steps to manage its impact:
- Choose the Closest Possible Hedge: Use derivatives that closely match the underlying asset—in terms of location, grade, and timing—to reduce the mismatch.
- Monitor Basis Movements: Track the historical relationship between your asset and the hedge instrument. Tools like Bloomberg and ASX market data can help you spot when the basis is unusually wide or volatile.
- Diversify Hedging Strategies: Combine different types of hedges or stagger maturities to spread out risk. For example, a portfolio of both futures and swaps may reduce overall exposure to a single basis risk event.
- Stay Informed on Policy and Market Trends: Regulatory changes and market shocks can shift correlations quickly. In 2025, government policy on carbon credits and agricultural subsidies has caused new basis risks in environmental and agri-commodity markets.
- Work with Experienced Risk Managers: Many Australian investment firms now offer dedicated basis risk assessment and monitoring as part of their portfolio services, reflecting the growing recognition of this risk in professional circles.
Looking Ahead: The Future of Basis Risk in Australia
Basis risk isn’t going away—in fact, as financial markets become more complex and interconnected, it’s likely to become more pronounced. Whether you’re a farmer, a super fund manager, or an individual investor dabbling in ETFs or derivatives, understanding basis risk is vital to protecting your returns and making smarter decisions. As 2025 unfolds, keep an eye on how local events, global trends, and new regulations shape the basis in your market—and make sure your risk management keeps pace.
