I have been investing in dry bulk Forward Freight Agreement (FFA) since 2004 and I can testify that journey’s excitement.
I’d like to share some of my takeaways here. Please note “shipping” in this writing refers to dry bulk shipping.
What makes shipping standout in investing?
First and foremost, shipping rates are a product of CURRENT supply/demand balance.
I call shipping an “honest” market. In most other asset classes, today’s value is about FUTURE expectations, be it expected future cash flow or expected future supply/demand equilibrium. As a result, there is a high degree of speculation in today’s asset price, as obviously that expectation is by definition a guess. When oil price falls to perceived low levels, people buy it for storage. In other words, they bring forward future expected consumption into today’s supply/demand. Human’s expectation tends to be mean reversion longer-term. Therefore the existence of future expectation in today’s price has the effect of reducing an asset’s volatility than otherwise.
This phenomenon does NOT exist in shipping, as shipping capacity is non-storable. One cannot save today’s excess shipping capacity for tomorrow. Therefore future expectation does not affect today’s shipping rate. This makes shipping rate a real-time and objective assessment of the current supply/demand balance without being distorted by future expectations.
If you only remember one point after this reading, it should be this one.
Secondly, shipping rates are volatile.
This is partially because of the first point above. Of the various asset classes I’ve observed, Capesize (dry bulk vessels carrying over 100k DWT) shipping rate is the second-most volatile. Spot rate annualized volatility stood at well over 100%. In a way this is similar to hotel room rates. One day you may want to reduce your rate just to fill a room, the following day a major conference can lead to huge spike in rates and full occupancy.
In shipping, the factors that influence demand could vary from weather to government policies without prior notice. The net result is a shipping rate subject to sudden and violent moves from time to time;
The third important feature about shipping is its extremely low correlation with other asset classes.
This is also a direct result of the first point. As most other asset classes are about future expectations, they are subject to the same thinking of certain future macro-factors. By definition, their assets price moves are correlated to each other, more or less. Spot shipping rates, however, are immune to this, as it’s not influenced by future expectations.
Therefore, we observe a minimal to negligible correlation between shipping rates and expectation-based asset classes.
Another important feature of dry bulk shipping is it's a fully competitive market.
This is made possible by a relatively low barrier to entry to the physical shipping. Such a market encourages technological innovation to help with competition.
Shipping as an asset class in investing
The above features of shipping make investing in it attractive…if you know what to do with it.
High volatility makes wonders for those willing and able to trade it.
Low correlation brings extremely valuable diversification benefit in today’s cross-asset class investing.
A fully competitive market makes manipulation more difficult thus fair play for all participants, even with a lack of sophisticated market regulation at present as in most other financial markets.
Having said that, in the long run, I think shipping is a terrible asset class to buy and hold. Humans are always trying to make their logistics more efficient and less costly over time through technological advancement. This is especially true in a fully competitive logistics industry. Reflected in shipping rate, I think it should under-shoot inflation rate over a relatively long period, as evidenced by my empirical study. This, of course would mean it’s generally a bad idea to long-term buy and hold shipping-related investments such as buying a vessel.
Personally, I find FFA trading stimulating. It is an intellectual game that requires intimate understanding of macro-economic development, international trade and certain industries, especially steel and utilities (as it stands now). I enjoy this game. I think I have a lot more to learn to enjoy more.
For our partners, that could mean new opportunities. I look forward to discussing this with you in our future communications.
Profision Shipping Capital Management Limited
This is an example investor letter sent in the past by our CEO, Jeffrey Yao, to clients. It provides general insights into shipping as an asset class but is not an inducement to invest nor should specific reliance be placed on its contents.