What do you think of when you hear the term “carry trade”?
We start thinking of the infamous Mr. John Devaney, who had to sell his 142-foot yacht named (wait for it…) “Positive Carry” during the financial crisis because of losses in his hedge fund due to the unwinding of, you guessed it — the carry trade.
But a recent whitepaper by Adam and Andrew Butler of ReSolve Asset Management is making us think of the infamous Carry Trade in a new way. While the carry trade is best known for how it’s implemented in the currency or FX markets, the new paper titled “Managed Futures Carry: A Practitioner’s Guide”, takes a comprehensive look at measuring and optimizing carry across liquid futures markets.
Here are some of the highlights:
What is Carry, Anyway?
This always seems to be a hard-to-define strategy outside the finance sphere, but the paper does a pretty good job explaining: carry is defined as the expected return from holding an investment — assuming no price change. It’s like collecting rent on a property, earning a return even if the price of the property doesn’t change. Carry is the reward you get just for hanging onto it — or “carrying” it, if you will. In the world of finance, it’s dividends, coupons, storage costs, and interest rate differentials that investors either earn or pay for holding an investment.
Measuring Carry
Measuring carry for thousands of individual investments in single-name stocks, hundreds of bonds, and dozens of commodity markets is surely a frustrating, time-consuming task. As ReSolve points out: “In equities, for example, we need to develop dividend estimates for thousands of companies around the world. For commodities, we would need to establish models of storage, transportation, and insurance costs for dozens of unique markets.”
The paper argues that futures markets inherently capture costs and benefits through contract pricing differences over time. The futures markets calculate carry somewhat differently based on available data sources, naturally capturing costs and benefits through contract pricing differences over time and, in turn, saving the carry practitioner a ton of time.
Types of Carry Strategies
The paper highlights various strategies for transforming carry into tradeable strategies. These approaches include:
Calendar spreads: If further dated contracts (e.g., December 2024) are trading at a higher (lower) price than near-term contracts (e.g., July 2024), sell (buy) the back-month against the front month. This approach isolates expected supply/demand dynamics in a given market at different points in the future
Cross-sectional carry: Futures markets with carry higher than the sector average will be held long against a similarly sized basket of assets with below-average carry. Through its long/short construction, this approach aims to neutralize directional market sector exposure and profit from the carry-driven, relative movement across markets in each sector
Time-series carry: Futures markets with positive expected carry are held long and those with negative expected carry are held short. As a result, the portfolio will maintain long and short-sector biases commensurate with the proportion of markets in each sector with positive or negative carry.
30 Years of Data: What’s the Takeaway?
The authors did some intensive data crunching and dug into more than three decades’ worth of market info to determine what makes carry returns tick. The main takeaway is that when you do it right, futures carry strategies can give your returns a boost while keeping risk in check. The secret sauce?
- Pay attention to correlations,
- keep your exposure to the S&P 500 and treasuries in line,
- and don’t forget about those pesky transaction costs.
But don’t take our word for it! Click here to download the white paper and see for yourself why carry deserves a spot in a well-rounded, diversified investment strategy.
