Navigating Investment Challenges

In our recent dialogues with various shipowners, we’ve observed recurring themes around the challenges of deciding when to invest in new assets, particularly in today’s environment of historically high newbuilding and secondhand asset prices. A question that many are grappling with is: “Is doing nothing the wiser decision?” We humbly share some of our reflections based on these discussions, focusing on the behavioral patterns we see influencing these decisions.

These tendencies can often be explained through the lens of behavioral finance, especially concepts such as herd behavior, overconfidence, and agency problems.

1. Herd Behavior: During strong markets, many companies feel compelled to follow their peers—especially those with a proven track record—which can lead to a surge in investments simply because “everyone else is doing it and we don’t want to be left behind.” Even with inflated asset prices, this mindset can perpetuate overinvestment, further overheating the market.
2. Overconfidence: Prolonged market booms can instill a belief that good times will continue indefinitely. This sense of overconfidence can drive shipowners to assume that investing in new vessels will yield consistent returns, despite soaring prices, leading to an underestimation of the risks involved in entering the market at a peak.
3. Agency Problems: Particularly in public companies, executives often face pressure from shareholders to act, rather than to hold onto cash. The expectation to seize growth opportunities in the strong market, that everybody else can’t seem to stop talking about, can lead to investment decisions that prioritise short-term gains over long-term strategic thinking, even when restraint might be the wiser choice.

These behaviors, while understandable, can lead to inefficiencies, as psychological biases and external pressures contribute to suboptimal investment decisions. For Japanese shipowners, we can’t help but notice that this is further amplified by various factors embedded within the system.

The Vicious Cycle for Japanese Shipowners

One of the key issues for Japanese shipowners is its tax policies that incentivise continuous reinvestment in new assets. This tax structure intensifies herd behavior, overconfidence, and agency problems. Rather than relying on market fundamentals, many owners feel driven to invest in response to tax pressures, which can collectively push the market into overinvestment cycles.

While tax policies are originally designed to encourage investment, they can sometimes exacerbate market cycles, leading to inefficiencies and poor business outcomes. Even in times of unfavorable market conditions, the desire to avoid hefty taxes may prompt investments that are guided more by tax considerations rather than by market signals. This dynamic can amplify overconfidence, as the perceived tax benefits may overshadow the cyclical risks of overcapacity.

Additionally, agency problems are compounded as business leaders may focus more on short-term tax savings than on long-term strategic goals, leading to decisions that could prove unsustainable in the long run.

In effect, the tax system acts as a kind of “fuel” for these behavioral tendencies, distorting decision-making and contributing to overinvestment during boom periods. Adjustments to tax policy—such as capping the amount that qualifies for tax relief or aligning incentives more closely with market conditions—could help mitigate some of these effects.

 

Strategies for Maintaining Cash Flows Amid Market Cycles

To navigate these complexities and maintain consistent cash flows throughout market cycles, many shipowners are exploring a range of strategies:

• Diversifying Investments: Instead of focusing exclusively on new ships, some shipowners are diversifying into related sectors such as logistics, ship management, or services along the shipping value chain. Others are investing in counter-cyclical industries like real estate, creating alternative revenue streams that reduce reliance on the shipping market.
• Sale-Leaseback Arrangements: By selling ships and leasing them back, shipowners can unlock capital, which can be used for operational costs, dividends, or investments elsewhere. This strategy also provides tax benefits without adding new vessels to an already crowded market, helping to smoothen their cash flows.
• Fleet Renewal Funds: Setting aside a portion of profits into dedicated funds for fleet renewal allows shipowners to invest when prices are lower, aligning acquisitions with predetermined market cycle indicators and avoiding high-priced purchases during booms.
• International Investments: Investing in markets outside Japan can offer more favorable tax environments and stable conditions to owners. Owners have been exploring international ventures, including funds, joint ventures with operators, investment into pool arrangements, and getting paid by partly shares whilst selling assets, to reduce their exposure to domestic tax obligations.
• Investing in Upgrades Over New Ships: Redirecting profits into upgrades for existing vessels—such as fuel-efficient retrofits—has become an increasingly popular strategy, driven by emission regulations and decarbonisation trends. These upgrades serve to reduce operating costs and enhance owner’s fleet competitiveness without expanding current fleet supply.
• Hedging and Financial Instruments: While more commonly used by charterers and operators, financial hedging tools like forward freight agreements (FFAs) and derivatives are gradually gaining traction in the ownership camp. These tools help stabilise earnings by locking in time-charter rates, mitigating market volatility and ensuring more predictable cash flows.

Implementing these strategies requires careful balancing, and we recognise that doing so in the current climate of high asset prices is no easy task. However, by approaching these challenges with discipline and a long-term view, shipowners will be able to navigate these times more effectively. As John C. Maxwell famously once said, “Motivation gets you going, but discipline keeps you going.”

 

By Eugene Quek, Partner & Head of Projects in Japan.