A different kind of “liquid” investment
Use rivers, channels and tributaries to generate cash flow.
Analysis by Dimitri Krikelas
Analysis by Dimitri Krikelas
16 March 2022
The vast network of rivers, channels, and tributaries comprising the U.S. inland marine transport system serves as a crucial building block of the national economy. Spanning more than 12,000 miles of commercially navigable waters, this natural freight network is relied upon to deliver everything from basic commodities and consumer products to agricultural staples and more.1 Besides fulfilling an important economic function, we also believe this space represents an opportunity for investors to add alpha in their portfolios and generate strong cash flow and total returns independent of traditional assets.
The underlying investment strategy—which Westmount clients can access through one of the diversified private funds on our private investment platform—consists of purchasing barges and towboats and leasing them out to operators who need to transport cargo (i.e., food, fuel, chemicals, coal, soybeans, corn, etc.) via U.S. waterways, including the Mississippi River and Gulf Coast.
Despite its size, this system is highly cost-efficient. Consider this: a barge can move one ton of cargo a whopping 514 miles on a single gallon of fuel. By contrast, a train travels just 202 miles per gallon, while trucks move roughly just 59 miles on the same amount of fuel.2 And the shipping activity over the marine transport system’s broad swath of territory occurs year-round, in virtually any economic climate.
Broadly speaking, much of the strong risk-adjusted returns generated in this sector have to do with a favorable regulatory backdrop. This includes The Jones Act—a 1920 law requiring all vessels carrying goods between two U.S. points to be built, owned, and crewed solely by American concerns. Originally intended to help the U.S. shipping industry bounce back following World War I, this mandate continues to eliminate the threat of competition from foreign interests.
On the more recent regulatory front, the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act has severely cracked down on securities lending and borrowing transactions. Consequently, players in this industry are generally well-capitalized, with solid balance sheets.
We believe this asset class can continue to deliver 10%+ annualized returns based on these favorable dynamics.
“Due to regulations restricting foreign competitors and a limited supply of capital attributable to Dodd-Frank, there is barely any competition within the marine inland transportation industry and thus major players are able to generate a compelling risk/return profile evidenced by historical returns and current capitalization rates,” explains Dimitri Krikelas, Westmount’s Chief Investment Officer for Private Markets. “We believe this asset class can continue to deliver 10%+ annualized returns based on these favorable dynamics and constrained capital within the space.”
Contractual, Consistent Cash Flow
Vessels are leased out to operators based on long-term (3-5 years), triple-net lease contracts. There is limited residual risk, evidenced by a near 100% utilization rate over the past 25 years despite several shocks to the macroeconomy, which supports the conviction that the asset class can generate cash flow in any market condition. Moreover, the demand for barges and towboats runs uncorrelated with the GDP, as vessel operators have renewed their lease contracts at a rate of 100% over the last several years.3
“Shippers know that if they fail to continually utilize these ships, they risk losing market share to their competitors, who also need vessels to transport goods throughout the Gulf and Mississippi,” says Mr. Krikelas. “In other words: business is good, and operators are determined to keep it that way.”
And what happens if a barge operator defaults on a lease or fails to renew a contract? “We haven’t seen this happen, but even if it did, there are enough renters to keep these businesses flowing,” noted Krikelas. “It’s like owning a multi-family apartment building, where if one rogue tenant doesn’t pay the rent for a prolonged time period, you can simply re-rent the unit and continue to collect income going forward.”
The marine transport asset class can also offer investors substantial tax benefits due to the naturally depreciating values of the shipping vessels. Under current IRS rules, an owner of inland marine equipment can depreciate 100% of the value of the asset in the first year of ownership, creating a meaningful tax shield for investors. Simply put, investors can leverage those values by using them to offset the 10% yields commonly seen. This strategy may be deployed for several years, until those deferred taxes are recaptured as long-term capital gains, only after the investment is sold.
“In the lead-up to that moment, the tax benefits can be significant,” notes Krikelas.
Risk Protection Through Diversification
The solid fundamentals attached to marine asset investments have historically resulted in 10% annual distributions paid on a quarterly basis—numbers particularly attractive to investors eager to generate a respectable cash flow yield, especially during a time when the 10-year treasury is yielding a mere 2%. But for many, the equity market is no less problematic.4
“Every day, there’s something to worry about—a war, a pandemic, another economic meltdown like the one we saw back in 2008. People are afraid to put all of their eggs in one stock market basket, and investors desire cash flow as well as an inflation hedge, so this asset class is a perfect differentiator,” says Krikelas.
The diversification baked into these types of river transport funds is yet another draw. For one thing, the type of products shipped are wide-ranging in scope. They may include raw materials, manufactured goods, coal, and farm products vital to the U.S. economy.
“It’s not like these funds lease vessels to operators who are shipping just one commodity that could present a concentration risk,” explains Krikelas. “So, even if one class of goods goes through a tough spot, it’s not going to cripple the entire portfolio.”
Beyond the goods transported, the staggered leasing terms likewise offer diversification, mainly because the expirations and renewals are laddered throughout the portfolio. And given that a lease matures every three months or so, the prices of the renewed contracts regularly climb higher to outpace inflation.
To access this and other institutional-grade, private investment strategies, Westmount has created and manages a multi-strategy, multi-asset class fund of funds. The fund seeks to generate an annualized 8%+ total return over a full market cycle with tax-advantaged, quarterly cash flow distributions and low volatility by investing primarily in private credit, private equity and real estate strategies.
Call us at 310-556-2502, visit westmount.com/alternatives, or contact your Westmount advisor directly to learn more.
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1U.S. Department of Transportation: https://www.maritime.dot.gov/sites/marad.dot.gov/files/docs/resources/3711/waterworksrev.pdf
2Livingston International: https://www.livingstonintl.com/services/freight-and-transportation/barge-services
3Maritime Partners. Additional information available upon request.
This report was prepared by Westmount Asset Management, LLC (“Westmount”), and is not intended for further distribution. Westmount is registered as an investment advisor with the U.S. Securities and Exchange Commission. The information contained in this report was prepared using sources that Westmount believes are reliable, but does not guarantee its accuracy. The information reflects subjective judgments, assumptions and Westmount’s opinion on the date made and may change without notice. Westmount undertakes no obligation to update this information. It is for information purposes only and should not be used or construed as investment, legal or tax advice, nor as an offer to sell or a solicitation of an offer to buy any security. No part of this report may be copied in any form, by any means, or redistributed, published, circulated or commercially exploited in any manner without Westmount’s prior written consent.
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