BDRY - BDRY: Consumption-Led Model For China Is Negative For Freight Rates
2023-05-08 17:29:46 ET
Summary
- BDRY provides direct exposure to freight futures, an asset class retail investors historically did not have access to.
- They can be incredible swing trading vehicles, as evidenced by the 800% return of BDRY from April 2020 to October 2021.
- Currently, the macro outlook is not favorable for freight rates, as China appears to be transitioning to a consumption-led economic model, which requires less bulk commodities.
The Breakwave Dry Bulk Shipping ETF ( BDRY ) is an innovative fund that gives investors direct access to freight futures.
The BDRY ETF can deliver incredible returns in the right circumstances like the COVID-19 re-opening in late-2020/early-2021, when the ETF returned over 800%.
However, the current macro-economic outlook is not favorable, as the Chinese economy appears to be transitioning to a consumption-led model, which requires less bulk commodities like iron ore.
I recommend investors stay on the sidelines on the BDRY ETF until there is another macro catalyst to tighten freight rates.
Fund Overview
The Breakwave Dry Bulk Shipping ETF gives investors long exposure to the dry bulk shipping market through a portfolio of freight futures contracts on dry bulk indices.
Strategy
The BDRY ETF is the first and only exchange traded product that focuses on dry bulk shipping freight futures. Historically, retail investors could only gain indirect exposure to the dry bulk shipping industry through publicly-listed equities such as Star Bulk Carriers Corp. ( SBLK ) while the freight futures market was reserved for accredited investors like hedge funds. However, the BDRY ETF attempts to open up the freight futures market to all investors by providing direct exposure to freight futures contracts (Figure 1).
Figure 1 - BDRY gives direct exposure to freight futures (BDRY investor presentation)
Freight futures contracts trade similar to other commodity futures and are settled in cash against the monthly average price of indices published by the Baltic Exchange. The BDRY ETF's model portfolio contains 50% capesize futures, 40% panamax futures, and 10% supramax futures (capesize, panamax, and supramax refers to the tonnage of the bulk shipping vessels).
Figure 2 - BDRY's model portfolio (BDRY investor presentation)
In order to minimize futures rolling costs, the BDRY ETF will hold freight futures with a weighted average of approximately 3 months to expiration using a mix of 1- to 6-month freight futures. The fund will hold monthly contracts to expiration and settle in cash while progressively buying the next quarterly contract as the months progresses (Figure 3).
Figure 3 - Mechanics of BDRY futures roll (BDRY investor presentation)
While the BDRY ETF may try to minimize futures rolling costs, ultimately, a strategy built on rolling futures contracts will still suffer decay if the futures curve is in contango (futures further out in time are at higher prices).
The BDRY is designed to profit from increases in freight futures beyond what is currently priced in the futures contracts.
Fees & Assets
The BDRY ETF has $72 million in assets as of May 6, 2023 and charges a high expense ratio of 3.5% (Figure 4).
Figure 4 - BDRY fund summary (etfmg.com)
Portfolio Holdings
Figure 5 shows the fund's holdings as of May 8, 2023. The fund currently has 40.9% of its portfolio invested in Panamax futures with expiries ranging from May to September. It has 57.9% of its portfolio invested in Capesize futures, and 10.4% invested in Supramax futures. Note, the total sums to greater than 100%, likely reflecting changes in mark to market ("MTM") values of the futures contracts, as the fund is not designed to be leveraged.
Returns
Overall, the BDRY ETF has delivered strong 3Yr average annual returns of 18.5% p.a. but terrible 5Yr average annual returns of -17.0% p.a. to April 30, 2023 (Figure 6). However, investors looking at annual return figures misses the incredible volatility from the dry bulk shipping freight futures asset class.
The COVID-19 pandemic was both the best and the worst of times for the dry bulk shipping industry, as the re-opening of the global economy in late-2020/early-2021 caused a surge in demand for commodities while heightened testing protocols caused congestion in major shipping lanes . This led to decade-highs in shipping freight rates, as shown by the Baltic Dry Index ("BDI") reaching 5,650, a level not seen since 2008 (Figure 7).
Figure 7 - Baltic Dry Index reached decade highs during COVID reopening (stockcharts.com)
This led to a surge in the BDRY ETF, with the ETF rallying from a post-COVID low of $3.75 to a high of $42.22, coinciding with the peak in the BDI in October 2021 (Figure 8).
Figure 8 - BDRY is highly correlated to Baltic Dry Index (Author created with price chart from stockcharts.com)
However, as more economies reopened in 2022 and supply chains normalized, the BDI collapsed by over 70% to a recent 1,500 level, and the BDRY ETF has likewise collapsed to $8.30, or a decline of over 80% from the October 2021 peak.
So while the 3Yr average annual total return figure of 18.5% looks strong at first glance, it encompasses an incredible 800% rally from April 30 to October 2021, and an equally incredible -80% decline from October 2021 to $8.30 recently.
What Happened To The Chinese Re-opening?
At the beginning of 2023, many analysts, myself included, anticipated a surge in commodities demand as China fully re-opened its economy after years of COVID lockdowns.
However, instead of a surge in demand for bulk commodities like iron ore and grains, we have actually seen the Chinese economy rebound on the back of consumer consumption instead of investment and construction like in prior recoveries.
As I warned in my January article on the Global X Copper Miners ETF ( COPX ), China's 2009 investment-led recovery led to a decade of corruption and excess, so Chinese authorities may not have been keen to re-use the old playbook.
Indeed, that appears to be the case, as price rallies in bulk commodities such as iron ore have fizzled on weak realized demand (Figure 9).
Figure 9 - Iron ore rally have fizzled in recent weeks (tradingeconomics.com)
At the same time, the Chinese people appear intent to follow their western peers in transitioning to a consumption-led economy, as demand for travel and luxury goods surges (Figure 10).
Figure 10 - Share price of LVMH, a luxury goods conglomerate, is trading at all-time highs (stockcharts.com)
Demand For Dry Bulk Follows Iron Ore
Iron ore, which accounts for roughly 1/3 of the global demand for dry bulk shipping, can be thought of as the main driver of freight rates (Figure 11).
Figure 11 - Iron ore is biggest driver to freight rates (BDRY investor presentation)
Given the muted outlook for Chinese steel demand, iron ore prices have softened significantly (see figure 9 above) and likewise dry bulk freight rates remain near lows.
Until and unless the Chinese economy returns to the previous investment-led growth model, I fear dry bulk freight rates may remain moribund near current levels (BDI ~ 1,500), which could cap returns for the BDRY ETF.
Conclusion
The BDRY ETF is an innovative fund that gives investors direct access to freight futures. The BDRY ETF can be an incredible swing-trading vehicle given the right circumstances, like the COVID-19 re-opening in late-2020/early-2021 which led to 800% returns.
However, the current macro-economic outlook is not favorable, as the Chinese economy appears to be transitioning to a consumption-led model, which requires less bulk commodities like iron ore. Until the macro picture changes, I recommend investors stay on the sidelines on the BDRY ETF.
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BDRY: Consumption-Led Model For China Is Negative For Freight Rates