The shipping cycle is famously volatile. Just ask anyone involved within the container shipping business in 2020-2022. Time it right, buy exposure to the cycle at the underside and sell at the highest, and also you’ll make a fortune.
Multi-generational Greek shipping families have this all the way down to a science. For on a regular basis investors, it’s a challenge. Shipping stocks have a maddening habit of not behaving like you think that they need to.
Breakwave Advisors, founded by John Kartsonas, created a brand new technique to put money into the shipping cycle in March 2018: the Breakwave Dry Bulk Shipping ETF (NYSE: BDRY), an open-end exchange-traded fund (ETF) that buys forward freight agreements (FFAs).
Its returns have closely mirrored the dry bulk freight cycle and haven’t been swayed by the vagaries of the broader stock market. BDRY was the best-performing ETF of 2021.
Breakwave’s next step: Branch out from dry bulk shipping into wet bulk shipping — the tanker market. The Breakwave Tanker Shipping ETF (NYSE: BWET) debuted May 3.
FreightWaves spoke with Kartsonas on lessons learned from the primary five years of the dry bulk fund, prospects for the brand new tanker fund and the way these futures-buying ETFs fit into the spectrum of ocean shipping investments.
The issue with shipping stocks
FREIGHTWAVES: Let’s say you should put money into shipping specifically to bet on the cycle — buy low, sell high. There are quite a lot of ways to do this. One option, when you’re managing a big investment fund, is to purchase the ships directly. We saw a variety of that within the early teens. What’s the downside of this strategy?
KARTSONAS: “Typically, it is rather difficult. It’s a really capital-intensive industry and it’s even tougher to do with tankers than with dry bulk. Why would you should buy the assets if all you care about as an investor is the cycle? A very powerful thing on this business is the exit strategy. When the market is in decline, no person desires to buy the falling knife, so that you’re stuck with the assets.”
FREIGHTWAVES: Trading shares of listed corporations is by far probably the most common way investors bet on the shipping cycle. The issue with shipping stocks is that on many occasions, rates are going up however the stocks are happening, and vice versa.
KARTSONAS: “The rationale I began serious about BDRY and BWET in the primary place was that when you desired to take part in the shipping market, you were stuck with shipping stocks. And with shipping stocks, there’s one other level of uncertainty, which is valuation.
“Shipping stocks are subject to the macro narrative at any given time. In the event you’re attempting to play the cycle and the stock doesn’t go up as much because it should or down as much because it should because you’ve this disconnect [between valuation and rates], how do you play the volatility, which is the essence of high returns?
“Tanker stocks follow energy stocks. So, when you think tanker rates are going to go higher and you purchase tanker stocks x, y and zed, chances are you’ll or may not actually earn money since it doesn’t only depend upon the direction of rates. It also is dependent upon the direction of the group within the stock market you might be an element of. In the event you are an element of the energy group and the energy group doesn’t do well, unfortunately, you’re not going to do well.”
Using freight futures as a substitute
FREIGHTWAVES: A method around the corporate valuation issue, particularly when you’re an institutional investor, is to go straight to the freight market and trade FFAs. But that’s not as easy as trading stocks.
KARTSONAS: “There are institutional investors which have the power and capital to do this. But at the top of the day, do you really need to have a dedicated person in your fund who looks only at freight? Because that’s the one way you possibly can trade FFAs. You could have to follow the market closely since it’s volatile. There are such a lot of things that make it cumbersome for institutional investors — and the tanker [FFA] market is far more difficult to access than dry bulk.”
FREIGHTWAVES: So, because of this you launched BDRY and BWET: to supply access to freight futures to anyone, from institutional to retail, and to supply a trading vehicle that follows the speed cycle more closely than shipping company stocks. Because as an open-end ETF that creates and redeems shares, BDRY and BWET never trade away from net asset value [NAV].
KARTSONAS: “BDRY and BWET connect the freight futures market to the stock market. That’s what it’s all about. And so they trade very closely, almost identically, to NAV. You understand that you just are buying the worth of the assets they hold, that are the futures. The ETFs won’t ever really be at a premium or discount to NAV, whereas when you buy stock in dry bulk company x, y or zed and also you’re buying at a reduction [to NAV], it doesn’t mean the stock goes to par. It’d go to an excellent greater discount.”
FREIGHTWAVES: BDRY was the best-performing ETF of 2021, with a complete return of 283%, in keeping with TheStreet. How difficult was it to get to that time because the launch in 2018?
KARTSONAS: “It was not the best-performing ETF in 2021 due to anything to do with the ETF itself. It was due to shipping market. There are only a few sectors within the stock market where when you are right, you possibly can generate returns as significant as you possibly can in shipping.
“It did take an extended time frame than I had expected for BDRY to get traction. The rationale, looking back, is that the typical investor wants a track record. They need to have the ability to drag up a chart that goes back not only six months, but a yr or yr and a half, to know where they’re within the cycle. But we got there. And now, with a five-year track record, it’s much easier for investors to know the cycle.”
Branching out into tanker futures
FREIGHTWAVES: Why did you select to go forward with the tanker ETF this yr?
KARTSONAS: “What we noticed with BDRY was that volumes increased in periods of volatility, which is sensible. If the market is low, individuals are attempting to buy the lows. If it’s high, individuals are attempting to sell or short the highs. In periods of stability, there isn’t much happening.
“You don’t need to bring a brand new product into the market when nothing is occurring. And until the war, the tanker market was very, very sleepy for a lot of, a few years.
“We saw rates waking up in the summertime of last yr. There are still a variety of disruptions to trade from the war, the orderbook is nonexistent and provide could be very, very limited. Which means utilization goes up, which I feel is positive for volatility. It took us some time to construct the product in a way that permits us to capture the volatility of the crude-tanker market and operate the ETF in a really efficient way.”
FREIGHTWAVES: How are BDRY and BWET similar and the way are they different?
KARTSONAS: “The general process could be very similar. We’re holding futures in each with a median duration of three months. Each products have very similar volatility profiles through the cycles.
“With BDRY it’s a mix of various indices [covering rates] around the globe, so it’s a more diversified product. [BDRY’s holds a 50% allocation of the Baltic Exchange Capesize index, with 40% allocated to the Panamax index and 10% to the Supramax index.]
“With BWET it’s 90% on one specific route from the Middle East to Asia for VLCCs [very large crude carriers; tankers with capacity of 2 million barrels] and 10% on the West Africa-to-Europe route for Suezmaxes [1 million-barrel capacity].
“One other difference is that dry bulk futures are priced in time-charter equivalent [TCE] rates, that are in dollars per day. Tanker futures are priced in dollars per ton. Each has its pros and cons but you’ve to work with regardless of the futures markets offer. The dollars-per-ton index has a bigger mixture of fuel cost, because technically TCE nets out fuel, and dollars per ton includes the worth of fuel. But we did a variety of work on this before launching BWET and located little or no sensitivity on a day-to-day basis with fuel prices.”
FREIGHTWAVES: Why this extreme give attention to VLCCs? VLCCs have been underperforming smaller tankers like Suezmaxes and Aframaxes, which have benefited more from war and sanctions disruptions.
KARTSONAS: “Again, now we have to work with the futures which are on the market. Probably the most liquid futures within the tanker market are VLCC futures. The liquidity in Aframax and Suezmax futures just isn’t significant, so we wouldn’t have the ability to construct the product around these segments. And to be honest, the VLCC market — the supertankers moving crude from the Middle East to China — is probably the most exciting for investors.
“This market is equally volatile [compared to dry bulk]. Three months ago, VLCC rates were $24 per ton. Now they’re $11. In the event that they return to $24, that’s a double. If things play out as many shipping analysts expect, it could go to $30 per ton. As an investor, you don’t even must capture that whole move to make a variety of money.”
Institutional versus retail investors
FREIGHTWAVES: For larger institutional investors, there’s also the block trade option. They should buy blocks in increments of 25,000 shares. Because that is an open-end ETF, those shares are created, not bought from existing shareholders, and when the investor desires to divest the block, it’s redeemed, not sold to other shareholders. In contrast, with a shipping company stock — even with the larger tanker names — larger investors face challenges getting out and in of major positions without moving the share price and losing a few of their gains.
KARTSONAS: “Sure, if an institutional trader desires to buy 25,000 shares or 100,000 shares, that will likely be executed immediately, and so they don’t should worry about [trading liquidity]. In the event you’re knowledgeable trader you possibly can do it with a phone call. The primary movers who did this in BDRY made a variety of money. Some doubled in a matter of weeks. The identical thing can occur with BWET, but I understand that folks are hesitant, since it’s a brand new product.”
FREIGHTWAVES: How do you see the combination of shopping for interest for institutional versus retail?
KARTSONAS: “Last yr we had 50,000 individuals who held BDRY at any given time. My gut feeling is it’s probably 70% retail and 30% institutional. Only a few sectors provide you with all these returns and I feel retail has discovered that. Some people think retail just isn’t the smart money. I feel the retail investor has proven to be much smarter than the institutional money. It’s demanding to choose bottoms or sell tops in shipping, but that’s the identical across any market and retail investors have found a technique to generate strong returns in a distinct segment area of the worldwide markets while institutional investors are still trading the identical stocks and the identical traditional assets.
“With BWET, I feel that, again, it’s going to take some time. Only a few people even know we’re around yet. And liquidity is cyclically dependent. If rates should not moving, there’s no reason to be involved in any of those products. Tanker rates have been very stable since we launched, but when now we have some style of event or there’s one other rally in VLCC rates, we’ll see more flows into BWET. The attention will come when tanker rates start to maneuver and other people search for alternatives to traditional tanker stocks.”
Addressing the concerns
FREIGHTWAVES: I also need to touch on among the concerns I’ve heard. The primary involves the U.S. tax rule on publicly traded partnerships that got here into effect this yr.
KARTSONAS: “The regulation affected all publicly traded partnerships and each BDRY and BWET are structured as publicly traded partnerships. In the event you hold stock in a publicly traded partnership, once you sell it, you’ve to pay 10% of the profits to the IRS when you are a non-U.S. investor. Together with other publicly traded partnerships, we got an exemption. But the entire responsibility lies with the broker. Some brokers for non-U.S. investors allow [the exemption] and a few don’t. There isn’t much we will do about it. It’s the broker’s alternative. But I feel around 90% of our investors are U.S.-based.”
FREIGHTWAVES: The opposite issue involves the expense ratio of as much as 3.5%, which is taken into account quite high for an ETF and which I assume pertains to the means of buying the FFAs.
KARTSONAS: “Unfortunately, that’s an enormous misconception. The effective expense ratio for BDRY and BWET is definitely a negative number. The rationale is that BDRY and BWET hold money as collateral to purchase futures. If you buy a futures contract, you should not actually buying anything. You’re just opening a contract and you’ve to have money as collateral. This could be very unique. Most ETFs — 98% or 99% of them — don’t hold money. They use money to purchase stocks. Rates of interest are much higher than they were five years ago. The interest [on the cash held by the BDRY and BWET] is 5%-plus per yr. If you subtract that, the effective expense ratio is a net profit to the investor.
“If someone says, ‘Oh, this expense ratio is simply too expensive,’ the fact today is that you just receives a commission to carry each BDRY and BWET.”
Way forward for Supply Chain
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