The Shipping Industry: An Opportunity for Portfolio Diversification

The shipping industry is booming and ripe for investment. But outsiders coming into the market are often greeted by an esoteric linguistic barrier. On today's episode, you'll learn all about why Nikos Nomikos believes we all can and should learn to speak the language of shipping derivatives. On Freight Up, Nikos Nomikos is a professor of shipping finance at Bayes Business School, formerly known as Cass. His area of expertise is ship finance risk management and asset pricing for shipping and commodity markets. A prolific author. He has published over 50 papers in peer reviewed academic journals and co authored the seminal work on shipping derivatives and risk management, which is very fittingly named shipping derivatives and risk management because of this and his deep interest in applied and commercially viable research.

0:55
Nikos is one of the most sought after researchers in his field working closely with corporations as both a consultant and in executive education. But more than this, Nikos is someone passionate about lowering the linguistic barrier to entry to investment opportunities within the shipping industry. In this episode, you will learn about the current state of the shipping industry, its future and how we get there. So without further ado. Here's Nikos. Nikos. All right. So I'm in the studio with Nikos Nomikos, one of the leading experts in shipping finance.

1:36
Wonderful to have you here. So for our listeners who may not be as familiar with your work as they're going to be by the end of this episode, can you tell them a little bit about, about yourself? Sure, thank you. So, I'm a professor of sipping finance at Bayes Business School.

1:52
One of the in fact the only business school located in the city of London being in a business school means that we have, we cover all sorts of disciplines and areas that you would expect to find in one of the leading universities such as entrepreneurship, finance, banking, but within the sort of broad disciplines, we also have a niche group that examines in far greater details, the intricacies of the shipping and commodity market. So this is the Costas Gramenos Center for Shipping Trade and Finance of which have been a proud member for the past 30 years, initially as a student and then as a faculty member, in terms of my background, I as you may have guessed from my surname and my accent originated from Greece. I grew up there, did my school there. I also did my undergraduate studies there. I studied Economics at the Athens University of Economics and Business coming from Greece meant that there were a lot of influences and stimuli that led me into shipping.

2:53
My late father was running his own shipping company. So that's how I got my first exposure into shipping. Then I moved to London to study, I did my master's degree at the what is now based business school then was known as the city University business School. I did my Msc in shipping trade and finance. And then I was offered a scholarship to study for a phd program and became a research assistant. I initially then a researcher, I worked on my Phd studies. And um actually, that's when I brought my first exposure into the area of freight derivative. So my studies at the time focused on how shipping companies could use the what was then known as the beef contract for the purposes of managing their freight exposure.

3:40
After completing my studies, I moved to the industry, I worked for the Baltic Exchange for a period of two years where I oversaw the development of number of freight market benchmarks such as the I think at the time was the BCI, the cape size index, the Panamax index as well as the BDI. And then back in 2001, I was offered a 10 year position at the university at the Center for Shipping Trade and Finance, a business school, initially as a lecturer, then senior lecturer, reader and for the past 14 years, a full professor in terms of my specialization and expertise, I'm focused on all aspects related to how shipping companies can manage their financial risks can use freight derivatives in order to hedge their freight exposure or in terms of enhancing their returns from their investment. But also look at aspects of shipping investment, valuation of shipping assets as well as issues such as how shipping companies should raise funds and what should be their optimum portfolio structure. So as far as getting the person who has a pulse on what shipping is doing its current state and why I picked the right guy is what you're telling me, put me on the spot there. Well, let's say that we need to have good awareness of what is going on, what is happening in the industry right now. And obviously being an academic means that I can express an opinion that has to be based on scientific facts. So these are the two sort of forces that I'm trying to balance all the time.

5:23
Yes, of course, it seems to me that being someone who is very quantitatively motivated, I think that we'll get along just fine considering that my master's is in data science, we do speak the same language and I'm so excited to get on to these questions. And I think my first one is really about the current demographics of the market. And it's been really interesting for me to see that charters really seem to be the more active party when it comes to freight derivatives than ship owners and I've been trying to understand why? Ship owners focus primarily on how to manage their costs. So their primary consideration is in terms of riding and surviving the notorious volatile shipping markets. So they try to be very efficient in how they manage their cost. But they look at the freight income, which is their main source of revenue as being an opportunity for far greater returns. And they view that opportunities for greater returns may be affected, may be constrained by the use of freight derivatives. Why do you think that sentiment might be?

6:45
I think this is primarily, I would say a misconception, I think that trade derivatives are a perfect instrument both in terms of managing the risk, but also in terms of creating a much more balanced portfolio of exposures and freight income. And I guess this is where my role as an educator comes in which is really to increase and to create the awareness about these instruments and how efficient and effective can be in a wide range of settings in a similar vein. That's kind of the role that you've taken on when it comes to institutional investors. Is that correct? So what has kind of been your methodology for getting institutional investors? And you know, obviously how can we cross apply that to ship owners and and getting people to want to speak the language of derivatives?

7:39
Yes, I think the issue of education there is very, very important. It is for a traditional shipping company that they use. And the concept of derivatives is not something that they may be or they feel familiar with. We see of course, that that gradually changes and shifts over the time, particularly within the university and our master's programs, we have a number of students that come and find out more about derivatives and how they are applied in a wide range of settings and markets. So there is now a far greater degree of familiarity with these instruments. It might just be your wonderful explanations here in Nikos. But I'm starting to think that maybe I don't need a Phd in quantitative finance to be able to participate in this market. Is that me just being a bit cocky or is that about reality?

8:31
No, I think that is the first statement to make it is and that applies not only to the freight market, it applies to other other derivatives market. There are aspects of the market that are highly quantitative and mathematically complex such as is the area of pricing, for instance, freight, derivatives, pricing, freight options in particular to be fair. Even in my case, if I want to price an F fa option and if I want to use an example of that in my classroom, in the in the lectures and in my interactions with the students, for instance, I can do everything using a spreadsheet. So there are nowadays of the self solutions that you can get that can do this most basic tasks. But in terms of trading, the market, in terms of trading fs, in terms even of understanding how a trade other than the general awareness of water, financial markets, what are the factors that drive the markets and the overall market sentiment and market document that every trader should have?

9:31
I don't think you would need anything more advanced in terms of quantitative or statistical skills. And if we do, we just hire one of your students. Right. Absolutely. Absolutely. The second I step to that F I S, that was the first thing I was greeted was was that stat that shipping is 92% of global trade. So to me, that seems like it's an incredible opportunity for portfolio diversification as someone who wishes to retire at some point. But that being said, shipping exposure isn't necessarily a mainstream topic.

10:15
It's not even a significant part of institutional investment portfolios. And I'm really curious as to why you think that is? Yes, thank you. That's a very good question.

10:24
As a matter of fact, indeed, shipping facilitates the vast majority of global trade. I like to say that shipping is what makes globalization possible if we look at the supply chains of different manufacturers, traders, industrial companies. Yet, despite the significance of and the role of shipping in the global economy, you are absolutely right. The the participation of institutional investors in the shipping industry is relatively small I believe there are two reasons for that.

11:02
One has to do with the awareness and the knowledge of outside investors. Of what is the shipping industry, how shipping markets operate and what are the key drivers in the market. And the second has to do with the accessibility of the market to outside investors. In addition, having in place mechanisms through which the markets can be made more readily available or more accessible to institutional investors is also a very important parameter. And to that extent, the inclusion of sipping indices from the SNP GSEI index that took place in August last year is a very important step in the right direction. So it sounds like the GSCI freight indices were really an effort from you and your partners to translate the language of derivatives to the language of the institutional investors. Exactly. So right now for an institutional investor to invest in freight trades, they will have to do it via the F fa market. But the F FA S, although a very useful tool for risk management may not be as effective for the purposes of long term investment because individual contracts expire and positions have to be rolled over to next nearest maturities. And so on, all these issues are taken into consideration explicitly in these indices because there is an automatic rollover and therefore you have an index that measures freight trade returns and freight trade exposure over two different periods of time.

12:53
We have short term and medium term indices and across the cape sizes and the Panama sectors. So that product relies and is based on the high liquidity that you have in the cape size and the Panama sector and uses the tried and tested mechanism of GSEI in order to create a product that is that gives you exposure to shipping freight rates, but also the ease of access that you would have in any other commodity market. So the ongoing narrative is that shipping is an industry, right for investment. But can you elucidate more on what some of those unique advantages are to an institutional investor? Absolutely. And I fully agree with your point of view.

13:43
There, there are a number of interesting aspects of shipping that make it a very unique market for an institutional investor. The first one is something we touch upon already and that has to do with the the role of shipping in the globalized economy and the fact that in the role that it plays in facilitating world trade. So there is a very interesting narrative in terms of how seeping facilitates and helps the global economy be globalized. There is also another very interesting development in terms of shipping. Shipping has embarked on a very ambitious decarbonisation program. So that also provides a very interesting investment angle from an E S G point of view. And there is also in the third aspect which is related to the statistical properties of trade trades. And despite the fact that shipping is so much intertwined with the global economy still as an asset class has relatively low correlation with other asset classes and therefore can potentially be a very useful divers to be included in a portfolio of equities bonds and global stock indices.

14:56
You did have one prediction that was a bit more controversial. Would you care to share that one with us? I'm offering a, a an example or providing an analogy from what is happening in other markets where we see that the paper market plays a much more dominant role in information and then price discovery. So I wouldn't be surprised if we reach a stage in the market where the forward market, the paper market plays a much more important role in determining the spot freight market. In fact, we see that happening in other commodity markets. The most notable example is the crude oil market where effectively the spot price is determined on the basis of the forward pricing. So I would see that as a as a positive development because it will lead to far greater efficiencies in pricing freight rates and also in offering price discovery in providing a freight trade that is reflective and reflects accurately uh market fundamentals.

16:02
So, Nikos I asked this on our regular podcast all the time and that is given what you've talked about. What is your one takeaway that you want this audience to walk away with, embrace the Ffa market. That's it simple as that. And that's what I've been trying to do throughout my professional life is to make the market a lot more aware about the benefits and the opportunities that the F fa market really provides for someone who's said, you know what? He's right. I'm going to embrace the Ffa market. What's the first thing I should do?

16:37
Educate, find out more about the Ffa market itself. And the second step is try to establish a network of contacts throughout the industry that can help in terms of providing the necessary information based to trade into the market. Lovely. Thank you so much for your time, Nico. So I hope you join us again in the future. My pleasure. Thank you, Fernanda. Well, that's it for today's special edition of Freight Up. We hope you enjoyed it. And if you haven't already make sure that you follow us on Apple podcast, Spotify or wherever you get your podcast from. If you have any questions or comments, make sure that you reach out to us at Freight Up at freightinvestor.com. That's Freight Up at freightinvestor.com. We hope you'll join us again next time.