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Digital Subscriptions > The Hedge Fund Journal > Issue 125 - August 2017 > Harvesting Global Carry

Harvesting Global Carry

Campbell white paper series − June 2017

RESEARCH

Many sophisticated quantitative investment managers employ systematic carry strategies in their portfolios, yet they remain poorly understood by the investing public due to a tendency to overgeneralize from a limited set of specific examples. Carry strategies are, in fact, a general class of investment opportunities, and can capture a wide array of phenomena in futures and forward markets. In this paper, we will explore three different types of carry trades, including relative value and directional approaches. We will attempt to debunk the perception that carry is, by definition, a highly-levered relative value strategy, and demonstrate that there is not a “one size fits all” approach to the carry trade.

Introduction

In a 2016 Campbell & Company white paper entitled “An Introduction to Global Carry,”1 the basic premise of generalized carry was introduced. “Carry” is an asset’s expected total return, positive or negative, assuming its price is unchanged.2 Regardless of the underlying asset, a carry strategy seeks returns from the net benefit or cost of holding that asset, in excess of the potential for price appreciation/depreciation.

Futures markets, which provide a standardized way to buy or sell a commodity or financial instrument at a specified future date and price, provide an excellent mechanism to harvest the carry risk premium. An asset’s “carrying costs” (or “carrying benefits”) are reflected directly in the futures term structure: the futures contract price at a particular tenor reflects both the current asset price (i.e., spot price) and the net cost or benefit of owning the asset (including both cash flow and non-cash flow items) until contract expiration. As expiration approaches, this carrying cost will diminish and approach zero, leading to a convergence between the futures price and the spot price.3 Extracting the carry risk premium embedded in the futures term structure can be achieved using several different methodologies. However, there is no way to capture carry in a particular market without some sort of price risk. Any attempt to completely hedge out the impact of price changes will also involve ‘hedging’ out any potential profit. An investor that attempts to capture carry in Gold, for example, by shorting Gold futures and buying Gold to hedge spot price risk, would find himself with zero profit at the end of the trade. By the time the investor paid the interest rate (or the opportunity cost) on the money used to buy the gold, paid the transportation costs, hired a security guard, etc., he would have eliminated any premium implied by a positively-sloped futures term structure. This is not a coincidence, but rather a natural consequence of spot-futures parity

Exhibit A Futures term structure example – RBOB gasoline on August 22 2012
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