On a recent visit to Gibraltar, I noticed what at first seemed to be a long queue of ships waiting to be unloaded at the Spanish port of Algeciras. I was soon put right, however, by one of my hosts from the Gibraltar government. These were ships without cargoes, or destinations. They had skeleton crews on board, and were awaiting instructions from their owners. In the meantime, they were losing money.

In this era of frantic global commerce, and the increased efficiency which technology brings to logistics and communications, it seems strange that the shipping industry can still produce a situation like this one, where over a dozen hulls are sitting empty, idling in the Mediterranean sunshine. Yet it is this very lack of efficiency that is being exploited by Global Maritime Investments (GMI), a dedicated shipping fund which was launched last year by two seasoned freight managers.

Let’s get physical

It is important at this point to highlight what makes GMI such a unique fund. While there are other hedge funds trading the maritime freight derivatives market, GMI is the only hedge fund to make use of the physical, dry bulk end of the industry on a global basis. Along with its futures exposure, its other main underlying asset is the Panamax vessel, ships classified as having the maximum dimensions possible to safely transit the Panama canal. The typical length for one of these vessels is 225 metres, with a beam of 32.3 metres, and a draft of 12.04 metres in tropical fresh water. As such, it is a very uniform commodity for GMI to be dealing in, but is also widely used as a shipping unit by larger users of cargo capacity, like mining companies.

GMI leverages its knowledge of the global market in Panamax hulls to exploit inefficiencies in the supply and demand of cargo capacity. It has chosen an area where there are large numbers of owners and participants, creating sufficient noise within the market for a hedge fund strategy to be able to function effectively. The container market is dominated by an oligopoly, while the tanker trade is controlled by the big energy companies and oil traders. Dry bulk, on the other hand, offers the shrewd trader more opportunities thanks to its relative diversity and level of fragementation.

GMI’s principals both have track records in the shipping industry. Joint managing director Stuart Rae has been in ship broking since the mid-1980s and was a founding partner of GMT Shipping. He later moved into freight trading on the BIFFEX (Baltic International Freight Futures) exchange, launching his own freight-trading company, EMC, in 1994. His business partner at GMI, Steve Rodley, is an ex-tanker broker who has worked for Mitsubishi Corporation and mining group BHP Billiton. At BHP he was the manager of Panamax freight operations, responsible for over 30 million tonnes of raw materials in these vessels.

It is this experience of trading both futures and actual physical capacity that stands the duo in good stead when it comes to running GMI’s portfolio. They are raising money for the fund at a time when their marketplace is rich in opportunity for a dynamic hedge fund strategy. It is an approach, they argue, that would be difficult to replicate with portfolio managers who have not had extensive experience of the shipping industry. Yes, a bank could move a trader over to freight futures from another market desk, but would he be able to understand an industry that can be notoriously opaque for the newcomer, let alone be able to trade physical cargo capacity?

Changing dynamics

But why launch a fund like this now? “The dynamics of the shipping industry have changed,” explains Rae. “We are seeing more liquidity and more volume. The dynamics of the commodities markets have also changed recently, and this is leading to an elasticity mis-match when it comes to the shipping market: the demand might be very elastic, but the supply is inelastic.”

In other words, a sudden demand for more ships by commodity producers cannot be swiftly matched – it takes time to build ships and put them on the water. This therefore places a premium on the existing fleets which are currently out there and able to cater to this demand. Commodities are also traded on a ‘just in time’ basis: buyers and sellers are averse to large stock-piles building up anywhere in the production cycle. Steel mills, for example, like to work at full capacity and reduce their storage costs to an absolute minimum. No-one wants to be sat paying for excess inventory. Much of the pressure falls on the shipping industry to ensure raw materials leave and arrive when they should. Discovering where this massive ocean-going distribution network is not meeting its objectives, and where profits can consequently be realised, is GMI’s job. For example, in April/May of this year, the fund’s managers were seeing an easing of congestion in Pacific iron ore loading ports, while congestion at coal-loading ports prevailed.

As if this were not enough, while many new ships have been laid down to meet the new demand for vessels occasioned by higher commodities prices, a large slice (25% by Rodley’s estimate) of the global Panamax fleet is over 20 years old and will become increasingly uneconomic to keep afloat. “I’ve got every confidence that this situation is here to stay,” says Rodley. “As the commodities boom has happened, we’ve seen everything else in the supply chain struggling to keep up.”

It is this awareness of the perspective of the big commodities producers and their clients have of the shipping industry that gives Rodley, with his background at BHP Billiton, an extra insight into where the backlogs are likely to occur, and how the fund can profit. It is bottlenecks in the supply chain that contribute to volatility in the prices being asked to rent hulls, and as with other sections of the hedge funds industry, it is volatility that brings opportunity for managers.

In addition, the commodities market itself can impact the shipping market: iron ore has been driving the Panamax market recently, due to the global demand for steel. Some estimates are claiming that China alone will import close to 400 million tonnes of iron ore by the end of this year, and GMI is keeping a close eye on the stockpiles of cheaper inventory and the iron ore spot prices in an effort to gauge the likely future demands for cargo capacity.

“We see a lot of opportunities in trading between the different classes,” says Rae. “The critical thing for us is the lack of consistent volume between the different geographical areas.”

Rae and Rodley are at pains to point out that there are a variety of participants in the Panamax market, and they are involved for very different reasons, and in different ways. For example, the Greek shipping families see the freighters as an asset play, looking out for the best times to buy and sell ships, when prices are at their peaks and troughs.

Along with the broad range of participants is the lack of a homogenous market on which cargo capacity can be traded, even with the apparent uniformity of the Panamax class itself. Despite the best efforts of some of the major commodity producers to launch a shipping exchange on this scale, there remains a distinct lack of homogeneity in the market. To succeed requires knowledge, and a large portfolio of connections within the industry. This is not a fund – or a strategy – that is easy to replicate. There are only a handful of shipping insiders around the world with the kind of experience level that GMI can bring to the table, and indeed, the fund’s principals have discovered this first hand in their own hunt for additional team members as their firm expands. Yes, the number of participants in the freight derivatives market has increased, including the larger banks, who are joining the freight derivatives market for the extra layer to their participation in the growth of the energy markets this provides, but trading freight derivatives is not the same as trading the physical market.

So how do you trade physical shipping freight? GMI rents and sub-lets Panamax vessels, of which there are an estimated 1600 currently operational around the world. The largest single owner of these vessels only controls approximately 60, so there is plenty of fragmentation in the market, coupled with the aforesaid lack of accurate real-time pricing information. GMI has the capability within the physical market to sub-let at any time in order to realise the profit on a deal – it is not stuck with long-term and costly commitments to ship owners. The relationship is more flexible than that between landlord and tenant in the property market. In liquidity terms, the GMI fund itself requires a six month notice period of its investors, and has a 25% gate, but the nature of the Panamax market allows it to enter and exit deals fairly fluidly.

GMI opened for investment with US$10 million in seed capital last year and had amassed US$85 million in AuM by July this year. Its principals expect to close to new investment once they reach approximately $250 million. “The shipping market itself has certain liquidity constraints,” says Rodley. “We can’t turn this into a US$10 billion hedge fund.” GMI is limited by the need to match cash trades, as well as the volumes within the forward freight agreement (FFA) market, and thus will likely close sooner rather than later if current asset gathering rates are anything to go by.

Expanding capacity

This does not mean GMI is not considering other means of expanding its capacity. One option is to move into other shipping markets. The firm is on the verge of hiring a new trader to oversee investments in the Handymax market (bulk carriers of between 35,000 and 60,000 tonnes displacement, and up to 200 metres in length). The Capesize market (ships too big to transit the Panama or Suez canals) is another potential area of expansion. Much depends on finding the right personnel with the expertise and the industry connections to manage such a freight portfolio effectively.

It is fair to say that GMI’s fund has been attracting a great deal of investor interest, particularly from family offices with little or no direct exposure to shipping, and more latterly from large institutions. Part of the appeal is that it lacks correlation to other markets and hedge fund strategies. The fact that it is a strategy that is difficult to replicate is also encouraging some investors to move into the fund before it closes.

The likelihood of other variants appearing on the street from rival firms is small. Apart from the lack of experienced personnel is the lack of an off-the-shelf risk management system that can be easily used to oversee a Panamax-based portfolio. GMI has built its own in-house, and considers it to be one of the best currently in use within the shipping industry. Indeed, Rae reckons that this lack of commercial risk management solutions within the sector is almost as big a barrier to entry as the personnel issue.

But GMI’s future plans are not simply about trading bulk cargo capacity. There are some other intriguing schemes onthe table. “Going forwards, we’re looking at other types of shipping exposure,” says Rodley. “For example, asset plays – buying and selling ships themselves, or a long/short funds investing in shipping equities. There is also the opportunity to launch an active freight derivatives fund.”

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Biographies

STUART RAE
Managing Director
Stuart Rae began his ship-broking career in 1986 in London and five years later was a founding partner, with major Taiwanese freight traders and shipowners, in GMT Shipping Limited (shipbrokers and freight consultants). Building up an extensive network of London, European, and Asian contacts, he developed freight derivatives to add value to their freight positions. He traded extensively and successfully on BIFFEX (exchange-based shipping derivatives) and in 1994 he co-founded EMC Limited, a freight trading company, with a prominent Greek shipping company.

STEVE RODLEY
Managing Director
Steve Rodley began his shipping career as a tanker broker in London in 1994, and joined Mitsubishi Corporation shortly after as a chartered manager involved in the coal and grain trades. In 1999 he joined BHP Billiton, one of the largest participants in the global freight markets, and was manager of Panamax Freight Operations, overseeing the carriage of over 30 million tonnes of raw materials in Panamax sized vessels.