Funds Ship Out in Search of Returns

2014-06-04

Hedge funds seeking big returns are heading for the high seas.

Ospraie Management LLC and Vermillion Asset Management LLC are among the funds that are betting freight rates for shipping are set to soar as global demand for everything from iron ore and coal to grains and sugar increases. Some investors argue that, in coming years, there won’t be enough ships to accommodate the growing need for transport, a situation that is likely to push freight rates higher.

Managers such as Louis Dreyfus Group are even starting new funds dedicated to shipping rates.

“There’s strong demand, and you don’t have the ships,” said John Kartsonas, a portfolio manager who oversees freight investments for Vermillion, a commodities hedge-fund firm with $1.1 billion under management. “For the next two years, there’s not a lot of things you can do to bring this market back to balance.”

Vermillion, which is majority owned by private-equity firm Carlyle Group, CG +1.78% recently boosted its exposure to freight rates on expectations they will rise this summer and through the second half of the year.

Money managers can bet on the direction of freight rates by buying and selling futures-like instruments known as forward freight agreements, which are largely traded over the counter. It is a murky market prone to some big swings, an attraction for funds seeking volatile markets to juice their returns.

Rising interest in the $15 billion freight market is yet another illustration of investors’ willingness to dive into risky and volatile financial instruments as they seek bigger returns. Freight rates collapsed from record levels after the 2008 financial crisis as a drop in demand for commodities collided with the delivery of many new ships that were ordered during the boom times of the early 2000s.

Just this year, freight rates—tracked by the widely watched Baltic Dry Index—have plunged 59%. Rates as tracked by the index would have to rise 12-fold to regain their precrisis peak.

The market also is affected by more than the health of the world’s economy. Rates tumbled this year in large part because of the cancellation of several soybean cargoes from the U.S. to China, as well as a ban by Indonesia of nickel exports.

But bullish investors say the latest setback to rates is temporary amid stable, albeit sluggish, global growth.

The Baltic Dry Index reflects freight rates for four different types of vessels plying 23 routes. Some of those rates are showing increasing gains, signaling that a bottom has been hit already, some analysts say.

Since the start of 2014, rates for the largest cargo ships, called “Capesize” because they must pass the Cape of Good Hope or Cape Horn to make their way between oceans, averaged $14,300 a day, according to Baltic Exchange Ltd., a London company that provides maritime-market information. That compares with an average per-day rate of $5,600 in the year-earlier period.

These daily “Capesize” rates have jumped to as high as $35,000 this year when China snapped up iron ore on the cheap, overwhelming the available capacity, traders said.

Trading volumes are up as well. In the first five months of the year, 495,213 forward-freight contracts changed hands, up 47% from last year and the most since the same period in 2008, according to Baltic Exchange.

“There’s been a change of sentiment,” said Jeremy Penn, chief executive of Baltic Exchange. “People started piling back into the market.”

Global trading firm Louis Dreyfus started a freight-focused fund, Edesia Lighthouse Fund LP, in November with $120 million in internal and external capital, prospective investors have been told; a fund representative didn’t return a phone call seeking comment. The fund was up 4% through March, according to investor documents. Ospraie Management recently has taken a bullish position on freight rates, according to people familiar with the fund manager.

To be sure, there is debate over how broad and sustained any rise in freight rates would be. And the market historically has been very volatile, putting any gains at risk. Lighthouse was up 8.1% in February but fell 5.8% in March.

“It doesn’t look that rosy,” said Philippe van den Abeele, chief investment officer of Consortium Maritime Trading Ltd., an investment firm that began taking positions in forward freight agreements in April with plans to raise $25 million in capital by year-end. “Any uplift in the market is to do with stresses in the logistics system when there’s short-term demand.”

Between 2010 and 2013, capacity rose 33% to 721 million deadweight tons, a measure of ships’ maximum weight including cargo, fuel and provisions.

“There’s still too many ships in the way, and it takes a while to clear out,” said Urs Dür, an analyst with Clarkson, the world’s biggest shipbroker by revenue.

Still, seaborne deliveries of dry commodities are forecast to jump 18% between 2013 and 2016, according to Clarkson’s data. Global iron-ore shipments hit a record 1.2 billion tons last year, driven by exports to China from Brazil and Australia. Shipments of coking coal and raw materials for aluminum production saw double-digit increases last year, and soybean deliveries jumped more than 7%.

Meanwhile, Clarkson estimates that growth in shipping capacity will slow. The shipbroker projects growth of 5% this year, 4.6% in 2015 and 3.6% in 2016. If borne out, the growth forecast for 2016 would be the smallest increase since 2004.

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