Monday, May 16, 2011

Freight Rate Derivatives: An Investment Idea Whose Time Has Come

Derivatives are best used to hedge risk, not to make bets on underlying macroeconomic moves.  Futures and forward contracts have been around for ages to allow dealers in raw materials to lock in prices.  The time has arrived for shippers to avail themselves of similar instruments to manage risk in freight prices.  Freight rate derivatives are ready for prime time.

It takes more than just demand from shippers to make these derivatives viable.  You need indexes against which bourses can measure a derivative's value; the World Container Index from Drewry and Cleartrade now exists.  You need counterparties ready to underwrite derivatives; some shippers are starting to take the other side of contracts

The market for freight rate derivatives won't be fully mature until major investment firms take on large roles in underwriting and the derivatives are regulated and traded on exchanges.  Like all derivatives, they are subject to abuse by traders who misuse them or misrepresent their risks to investors. 

Derivatives offer shippers a tool that can complement traditional long-term delivery contracts.  This is a welcome development.