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Steve Rodley and Stuart Rae: navigating a sea of opportunities |
Steve Rodley calls shipping "the second oldest profession", and he could be right. Yet only about half a dozen hedge funds cover this deep and historical industry globally. Rodley’s is one of them. M2M Management, manager of the Global Maritime Investments hedge fund, is active in the physical and derivatives market of dry bulk shipping – cargoes such as coal, iron ore, industrial raw materials, grain and fertilizers, and the ships that carry them. The fund focuses primarily on the Panamax sector – 75,000-tonne ships, 230 metres long, that are so named because they are the maximum size that can negotiate the Panama Canal. Since the fund’s inception in October 2006, annualized returns of 31% net of all fees have been posted. Performance like that, coupled with the lack of correlation with other markets, is attracting attention from investors, and the fund has already reached $50 million from its $10 million starting point.
The biggest reason why there are opportunities in the shipping market for hedge funds such as M2M is that the industry attracts an array of people with different agendas. "There are people such as the traditional Greek shipowners who buy and sell ships and who are asset players. They pick the optimal timing to buy and sell and their natural inclination is to hire those ships out for as long as possible so they can keep their lending banks happy," says Rodley. "There are others who have cargo to move, like a power station, who don’t want to hire ships but simply want to pay someone to move coal from one place to their plant. And then, there are those trading forward freight futures off the back of energy, power and gas markets who are hedging hidden freight risk."
These mismatches in demand for shipping allow the fund to take advantage. On the physical side, M2M can look for periods when ships are cheap to hire, and act as the intermediary supplying ships around the world to where the demand for dry bulk shipping is highest.
M2M has to consider where the demand for ships that it is hiring from owners is greatest. "One of the biggest trades for us is a geographical play," says Rodley. "Do you want to position your ships ready for hire in the Atlantic or the Pacific, for example?" As the oceans are connected, he says, if the market is high in the Atlantic and supply of ships there is limited, demand will be met by ships moving in from the Pacific, and that will balance out the markets. But before equilibrium is reached, opportunities arise from understanding the quirks of the market and where the demand will be.
On a less grand scale, smaller geographic pockets of demand can also open up. "Last year there was localized port congestion in Australia. Ships were queuing to unload and it was restricting supply; people were waiting for ships to free up. In that case, the Pacific market screamed higher in the short term, but then empty ships sailed in from the Atlantic and balanced the markets," says Rodley.
The supply side of shipping is essentially inelastic, which also creates opportunities. "Demand for ships can be spiky depending on the markets for raw materials going into steel. The commodities boom, in part led by demand from China, has increased demand," says Rodley. "But ships and ports cannot be built overnight to counter that demand. Also, there are bottlenecks as people try to push cargo through ports. That leads to congestion."
On the derivatives side, M2M trades forward freight agreements (FFAs), and makes its money on the difference between these futures prices and the physical shipping that it takes part in, making a pure arbitrage and relative-value play from the mismatches and mispricings between the two. "We’re not doing directional plays here," says Rodley. "Whenever we hire a ship for, say 360 days, we will always hedge off by doing a contract with a mining company to move cargoes, or selling FFAs."
Forward freight agreements are based on a series of indices produced daily by the London-based Baltic Exchange that show the cost of hiring a range of ships across different geographical locations. As freight demand volatility has increased alongside demand for commodities, so too have trading volumes in dry FFAs. The Baltic Exchange reported a 4% increase in the number of lots traded in the dry freight derivatives market in the first quarter this year compared with the final quarter of 2006. "People needing to use FFAs to hedge, perhaps because they own a series of iron ore mines, tend to be focused on only one geographical region," says Rodley. "It you’re in Brazil exporting to the US and Europe, you’re only going to be worried about the Atlantic FFAs, Because we have knowledge globally we can find arbitrage opportunities between the different regions."
Rodley started the firm, which manages the Global Maritime fund from offices in London and Athens, with Stuart Rae. Both have a shipbroking background, and Rae also traded shipping derivatives and founded EMC, a freight trading company.