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An Introduction to Global Carry

Campbell & Company examines powerful impact of carry strategies

A n investor (let’s call her Carrie) purchases an investment property for $1 million. A year later, she sells the property for the same $1 million price. Since there was no price appreciation, why might Carrie be happy with such an outcome? The answer is that price appreciation (or depreciation) is not the only potential source of return. Other factors that can impact Carrie’s return on investment may include mortgage interest payments, rental income from lessees, and any other costs or benefits from holding the property for a year. In this particular case, if the rental income exceeds the mortgage interest, this will be a profitable investment for Carrie despite the fact that the property did not change in value.1 Holding, or ‘carrying’ this asset provided a net benefit beyond price movements; a trader would call this ‘positive carry.’

This example, though simple, is intended to demonstrate that every investment has two potential sources of return:

• Price appreciation/depreciation;

• The costs and benefits associated with holding an investment.2

Fig.1 Costs and benefits of holding an asset, by asset class
Source: Campbell & Company

Directional investment strategies tend to focus on the first component: they seek returns from price appreciation (or depreciation in the case of short positions). For example, trend following strategies seek to identify price trends, both upwards and downwards, and take long or short positions to profit (or lose) from further price moves in the same direction.3

Carry strategies aim to maximise exposure to the second component: they seek returns from the net benefit or cost of holding an asset (in excess of the potential for price appreciation/depreciation). Carry strategies will take long positions in markets with a positive net benefit and short positions in markets with a negative net benefit (i.e., net cost). Carry is an asset’s expected total return 4 assuming its price is unchanged. (This definition is intended to capture the ‘spirit’ of carry; however, a more precise way to express this concept is that carry is an asset’s expected total return assuming the relevant ‘market conditions’ remain unchanged. For fixed income, the relevant market condition may be the term structure of bond yields, while for commodities it may be the futures term structure. For foreign exchange and equity indices, it may be the spot price of the underlying.

In general, if the benefits from holding an investment exceed the costs,5 it is considered ‘positive carry.’ This means that, in effect, the investor is being compensated for holding the asset. Conversely, if the costs exceed the benefits, it is ‘negative carry’ and the investor is compensated for shorting the asset. In this way, carry strategies seek to earn what is often termed the ‘carry risk premium.’

In this paper, we seek to provide a high-level introduction to carry, demonstrate how it can be generalised across asset classes, and explore the significant synergies between carry and directional investments, such as trend following and traditional asset portfolios.6

Fig.2 Fixed Income Carry Trade Example - Japanese 10Y Government Bonds
Source: Bloomberg
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