The shipping cycle is famously volatile. Just ask anyone involved in the container shipping business in 2020-2022. Time it right, buy exposure to the cycle at the bottom and sell at the top, and you’ll make a fortune.

Multi-generational Greek shipping families have this down to a science. For everyday investors, it’s a challenge. Shipping stocks have a maddening habit of not behaving like you think they should.

Breakwave Advisors, founded by John Kartsonas, created a new way to invest in 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 have not 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 first five years of the dry bulk fund, prospects for the new tanker fund and how these futures-buying ETFs fit into the spectrum of ocean shipping investments.  

This question-and-answer interview was edited for clarity and length.

The problem with shipping stocks

FREIGHTWAVES: Let’s say you want to invest in shipping specifically to bet on the cycle — buy low, sell high. There are a number of ways to do that. One option, if you’re managing a large investment fund, is to buy the ships directly. We saw a lot of that in the early teens. What’s the downside of this strategy?

KARTSONAS: “In general, it is very difficult. It is a very capital-intensive industry and it’s even more difficult to do with tankers than with dry bulk. Why would you want to buy the assets if all you care about as an investor is the cycle? The most important thing in this business is the exit strategy. When the market is in decline, nobody wants to buy the falling knife, so you’re stuck with the assets.”

FREIGHTWAVES: Trading shares of listed companies is by far the most common way investors bet on the shipping cycle. The problem with shipping stocks is that on many occasions, rates are going up but the stocks are going down, and vice versa.

KARTSONAS: “The reason I started thinking about BDRY and BWET in the first place was that if you wanted to participate in the shipping market, you were stuck with shipping stocks. And with shipping stocks, there is another level of uncertainty, which is valuation.

“Shipping stocks are subject to the macro narrative at any given time. If you’re trying to play the cycle and the stock doesn’t go up as much as it should or down as much as it should because you have 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, if you think tanker rates are going to go higher and you buy tanker stocks x, y and zed, you may or may not actually make money because it doesn’t only depend on the direction of rates. It also depends on the direction of the group in the stock market you are a part of. If you are a part of the energy group and the energy group doesn’t do well, unfortunately, you’re not going to do well.”

Using freight futures instead

FREIGHTWAVES: One way around the company valuation issue, particularly if 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 that have the ability and capital to do that. But at the end of the day, do you really want to have a dedicated person in your fund who looks only at freight? Because that’s the only way you can trade FFAs. You have to follow the market closely because it’s volatile. There are so many things that make it cumbersome for institutional investors — and the tanker [FFA] market is much more difficult to access than dry bulk.”

FREIGHTWAVES: So, this is why you launched BDRY and BWET: to provide access to freight futures to anyone, from institutional to retail, and to provide a trading vehicle that follows the rate 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 they trade very closely, almost identically, to NAV. You know that you are buying the value of the assets they hold, which are the futures. The ETFs will never really be at a premium or discount to NAV, whereas if you buy stock in dry bulk company x, y or zed and you’re buying at a discount [to NAV], it doesn’t mean the stock is going to par. It might go to an even bigger discount.”

FREIGHTWAVES: BDRY was the best-performing ETF of 2021, with a total return of 283%, according to TheStreet. How challenging was it to get to that point since the launch in 2018?

KARTSONAS: “It was not the best-performing ETF in 2021 because of anything to do with the ETF itself. It was because of the shipping market. There are very few sectors in the stock market where if you are right, you can generate returns as significant as you can in shipping.

“It did take a longer period of time than I had expected for BDRY to get traction. The reason, looking back, is that the average investor wants a track record. They want to be able to pull up a chart that goes back not just six months, but a year or year and a half, to understand where they are in the cycle. But we got there. And now, with a five-year track record, it’s much easier for investors to understand the cycle.”

Branching out into tanker futures

FREIGHTWAVES: Why did you decide to go forward with the tanker ETF this year?

KARTSONAS: “What we noticed with BDRY was that volumes increased during periods of volatility, which makes sense. If the market is low, people are trying to buy the lows. If it’s high, people are trying to sell or short the highs. During periods of stability, there isn’t much happening.

“You don’t want to bring a new product into the market when nothing is happening. And until the war, the tanker market was very, very sleepy for many, many years. 

“We saw rates waking up in the summer of last year. There are still a lot of disruptions to trade from the war, the orderbook is nonexistent and supply is very, very limited. That means utilization is going up, which I think is positive for volatility. It took us a while to build the product in a way that allows us to capture the volatility of the crude market and operate the ETF in a very efficient way.”

FREIGHTWAVES: How are BDRY and BWET similar and how are they different?

KARTSONAS: “The overall process is very similar. We’re holding futures in both with an average duration of three months. Both products have very similar volatility profiles through the cycles.

“With BDRY it’s a combination of different indices [covering rates] around the world, 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].

“Another difference is that dry bulk futures are priced in time-charter equivalent [TCE] rates, which are in dollars per day. Tanker futures are priced in dollars per ton. Each has its pros and cons but you have to work with whatever the futures markets offer. The dollars-per-ton index has a larger mix of fuel cost, because technically TCE nets out fuel, and dollars per ton includes the price of fuel. But we did a lot of work on this before launching BWET and found very little sensitivity on a day-to-day basis with fuel prices.”

FREIGHTWAVES: Why this extreme focus on VLCCs? VLCCs have been underperforming smaller tankers like Suezmaxes and Aframaxes, which have benefited more from war and sanctions disruptions.

KARTSONAS: “Again, we have to work with the futures that are out there. The most liquid futures in the tanker market are VLCC futures. The liquidity in Aframax and Suezmax futures is not significant, so we wouldn’t be able to build the product around these segments. And to be honest, the VLCC market — the supertankers moving crude from the Middle East to China — is 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. If they go back 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 need to capture that whole move to make a lot of money.”

Institutional versus retail investors

FREIGHTWAVES: For larger institutional investors, there’s also the block trade option. They can buy blocks in increments of 25,000 shares. Because this is an open-end ETF, those shares are created, not bought from existing shareholders, and when the investor wants to divest the block, it’s redeemed, not sold to other shareholders. In contrast, with a shipping company stock — even with the bigger tanker names — larger investors face challenges getting in and out of major positions without moving the share price and losing some of their gains. 

KARTSONAS: “Sure, if an institutional trader wants to buy 25,000 shares or 100,000 shares, that will be executed instantly, and they don’t have to worry about [trading liquidity]. If you’re a professional trader you can do it with a phone call. The first movers who did this in BDRY made a lot of money. Some doubled in a matter of weeks. The same thing can happen with BWET, but I understand that people are hesitant, because it’s a new product.”

FREIGHTWAVES: How do you see the mix of buying interest for institutional versus retail?

KARTSONAS: “Last year we had 50,000 people who held BDRY at any given time. My gut feeling is it’s probably 70% retail and 30% institutional. Very few sectors give you these types of returns and I think retail has discovered that. Some people think retail is not the smart money. I think the retail investor has proven to be much smarter than the institutional money. It’s not easy to pick bottoms or sell tops, but that’s the same across any market and retail investors have found a way to generate strong returns in a niche area of the global markets while institutional investors are still trading the same stocks and the same traditional assets.

“With BWET, I think that, again, it’s going to take a while. Very few people even know we’re around yet. And liquidity is cyclically dependent. If rates are not moving, there’s no reason to be involved in any of these products. Tanker rates have been very stable since we launched, but if we have some type of event or there’s another rally in VLCC rates, we’ll see more flows into BWET. The awareness will come when tanker rates start to move and people look for alternatives to traditional tanker stocks.”

Addressing the concerns

FREIGHTWAVES: I also want to touch on some of the concerns I’ve heard. The first involves the U.S. tax rule on publicly traded partnerships that came into effect this year.

KARTSONAS: “The regulation affected all publicly traded partners and both BDRY and BWET are structured as publicly traded partnerships. If you hold stock in a publicly traded partnership, when you sell it, you have to pay 10% of the profits to the IRS if you are a non-U.S. investor. Along with other publicly traded partnerships, we got an exemption. But the whole responsibility lies with the broker. Some brokers for non-U.S. investors allow [the exemption] and some don’t. There isn’t much we can do about it. It’s the broker’s choice. But I think around 90% of our investors are U.S.-based.”

FREIGHTWAVES: The other issue involves the expense ratio of up to 3.5%, which is considered quite high for an ETF and which I assume relates to the process of buying the FFAs.

KARTSONAS: “Unfortunately, that’s a big misconception. The effective expense ratio for BDRY and BWET is actually a negative number. The reason is that BDRY and BWET hold cash as collateral to buy futures. When you buy a futures contract, you are not actually buying anything. You’re just opening a contract and you have to have cash as collateral. This is very unique. Most ETFs — 98% or 99% of them — don’t hold cash. They use cash to buy stocks. Interest rates are much higher than they were five years ago. The interest [on the cash held by the BDRY and BWET] is 5%-plus per year. When you subtract that, the effective expense ratio is a net benefit to the investor.

“If someone says, ‘Oh, this expense ratio is too expensive,’ the reality today is that you get paid to hold both BDRY and BWET.”

Click for more articles by Greg Miller 

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