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Discover A “New” Asset Class,  Or 3 Ways To Invest In Shipping Without Buying Ships

|Includes: Breakwave Dry Bulk Shipping ETF (BDRY), SEA
Summary

Why Invest in Shipping.

How to Invest in Shipping.

Factors Driving the Shipping Industry.

“God must have been a shipowner. He placed the raw materials far from where they were needed and covered two thirds of the earth with water.” Erling Naess, Norwegian Shipowner 1901-1993

Shipping is a vital part of the global economy and an integrated part of commodity trading. Crude Oil, Iron Ore and Coal are the three major commodities shipped around the world. China dominates the demand side, with more than 80% of incremental seaborne volumes going to China over the last decade. The source of commodities is quite disperse, with both the Atlantic basin and the Pacific basin supplying cargoes to the market.

Why Invest in Shipping

If it seems like just about every asset class is expensive, then you’re probably paying good attention to reality. Most indicators show an unpleasant situation where 3 of the major asset classes, stocks, bonds, and property, are all overvalued.

An allocation into dry bulk shipping may improve overall portfolio risk-adjusted returns due to the uncorrelated nature of the sector at a period when the industry is experiencing a cyclical upturn.

Dry bulk shipping is a very good diversifier, with very low correlation to other asset classes and a levered play on the commodity cycle with high beta and volatility compared to the underlying commodities.

Analysts continue to see positive fundamentals for the year ahead with both supply/demand balance tightening and regulatory changes adding to possible disruptions in trade that can be beneficial for freight rates.

On top, starting January 1, 2020, every commercial vessel will be required to start burning low sulfur fuel to meet the new environmental standards. As a result of this change, forward fuel prices are already being impacted. Although the global fleet has slowed down considerably in the last several years, the potential increase in fuel prices could cause the fleet to slowdown even more, restricting supply and tilting the market balance towards stronger rates (higher freight rates).

How to Invest in Shipping

Other than buying a ship, there are three different ways for investors to build exposure to the shipping industry into their portfolios.

Exchange-Traded Funds (ETFs)

ETFs are the easiest and the most efficient way to invest in the shipping industry since they provide diversified exposure in a single security. There are two ETFs in the market.

The Breakwave Dry Bulk Shipping ETF (NYSE Arca: BDRY) is the first and only ETF focused on Dry Bulk Shipping. BDRY holds freight futures contracts on dry bulk rates, thus providing the most direct exposure to dry bulk shipping short of owning ships.

“It follows actual rates,” John Kartsonas, founder and managing partner at Breakwave Advisors, told TradeWinds recently. “So, for someone who believes that rates are going higher, BDRY offers that simple pure exposure without the noise coming from the Wall Street narrative, headline news and investor expectations.”

BDRY holds and let existing contracts settle in cash while gradually buying the next calendar quarter contracts, thus providing a cost efficient and gradual “roll”, minimizing any negative impact from rolling positions (dry bulk futures settle in cash and there is no physical delivery, thus there is no embedded “carry cost” in the futures curve).

The other ETF is the Invesco Shipping ETF (NYSE Arca: SEA). SEA tracks an index of global maritime shipping stocks selected by dividend yield and weighted by market cap.

SEA is based on the Dow Jones Global Shipping Index. The Fund will invest at least 90% of its total assets in stock and depositary receipts that comprise the Index. The Index measures the performance high dividend-paying companies in the global shipping industry; mainly container exposure and LNG. The Index is computed using the gross total return, which reflects dividends paid. The Fund and the Index are rebalanced quarterly.

SEA is a hybrid: part industry-niche fund and part dividend fund. It focuses on global shipping firms and delivers a top-heavy basket of stocks that mirrors the market in this respect.

Individual Stocks

Another way to invest in the global shipping industry is by selecting individual stocks. Specifically in dry bulk, there is a universe of 14 stocks; most of them are low cap though and with limited liquidity - combined daily volume is being lower than $20m.

Disadvantages of stocks vs freight rates, other than liquidity, include company-specific risks, dilution risks as well as corporate governance and management issues. Finally, it’s the broader equity market risk. Freight rates and futures generally have exhibited low correlation to equity markets.

Forward Freight Agreements (FFAs)

The 3rd way is through FFAs. A Forward Freight Agreement is a financial forward contract that allows ship owners, charterers and speculators to hedge against the volatility of freight rates. It gives the contract owner the right to buy and sell the price of freight for future dates. FFAs are traded “over the counter”, on a principal-to-principal basis and can be cleared through a clearing house. It’s a difficult market to enter, with high barriers, a few active accounts globally and needs high specialization in order to properly track it.

Factors Driving the Shipping Industry

There are three factors driving the shipping industry:

Supply: This is the number of vessels that are currently available in the market to transport goods.

Demand: This is the demand for goods, mainly crude oil, iron ore, coal and grains which are the main commodities transported by ships. Asia, and more specifically China, represent the great majority of demand, making shipping a levered play on Asian and Chinese trade and growth.

Costs: This is the cost of operating a vessel and long-term costs, which includes both bunker fuel costs and the cost of debt i.e. interest payments.

Investors should be cognizant of these three factors when analyzing the industry. For instance, the Baltic Dry index could rebound (signaling greater demand and/or less supply), but the benefits to shipping companies could be offset by higher bunker fuel prices.

On the other hand, investing through futures provides investors the highest correlation possible to shipping thus bypassing a lot of the negatives that comes with direct shipowning i.e. operational risk, not 100% utilization, mismatch between index rates and actual achieved rates, high commissions, etc.

Conclusion

The shipping industry is the lifeblood of the global economy. While the sector has struggled over the past several years, since the end of 2016, we have been witnessing a rather impressive recovery being noted, especially in the dry bulk market.

An allocation into dry bulk shipping may improve overall portfolio risk-adjusted returns due to the uncorrelated nature of the sector at a period when the industry is experiencing a cyclical upturn.

In a world where nearly every asset class is expensive by historic standards, the dry bulk shipping sector stands out as an exception.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.