Swedroe: Carry Factor Spans Assets

August 30, 2017

One of the problems facing investors is that there are hundreds of investment factors populating a veritable factor “zoo.” In our book, “Your Complete Guide to Factor-Based Investing,” my co-author Andrew Berkin and I reduce the number of “exhibits” worth visiting to just seven by establishing five criteria that a factor must meet before you consider investing in it. One of those seven is the carry factor.

The carry factor is the tendency for higher-yielding assets to provide higher returns than lower-yielding assets. It is a cousin to the value factor—the tendency for relatively cheap assets to outperform relatively expensive ones. A simplified description of carry is the return that an investor receives (net of financing) if an asset’s price remains the same.

Carry Across Asset Classes
The classic application of carry involves currencies; specifically, in going long currencies of countries with the highest interest rates and shorting those with the lowest. Currency carry has been both a well-known and profitable strategy over several decades. However, the carry trade is a general phenomenon, and not limited to currencies.

For example, in commodities, assets with a term structure exhibiting futures in backwardation (futures prices are lower than spot prices) should generate a positive roll yield and, therefore, a positive excess return when market conditions remain unchanged. These assets should thus be overweighted in a carry portfolio.

Conversely, commodities exhibiting futures in contango (futures prices are higher than spot prices) should be underweighted. In other words, in commodities, carry is the slope of the futures curve. In bonds, carry is the slope of the yield curve. And in stocks, carry is the expected dividend yield.

It has been well-documented in recent literature that carry has been profitable across asset classes. For example, Ralph Koijen, Tobias Moskowitz, Lasse Pedersen and Evert Vrugt, authors of the 2016 study “Carry,” found that a carry trade taking long positions in high-carry assets and short positions in low-carry assets earned significant returns in each of the asset classes they examined, with an annualized Sharpe ratio of 0.8 on average.

Further, a diversified portfolio of carry strategies across all asset classes earned a Sharpe ratio of 1.2. They also found that carry predicts future returns in every asset class, although the strength of that predictability varies across them.


Recent Research

Nick Baltas contributes to the literature on carry with his May 2017 paper, “Optimising Cross-Asset Carry.” The paper focuses on the returns of a globally diversified, multi-asset class carry strategy.

The data sample covers January 1990 through January 2016 and included 52 assets: 20 commodities (constituents of the Bloomberg Commodity Index excluding precious metals, e.g., gold and silver), eight 10-year government bonds, nine FX rates (G10 pairs against the U.S. dollar) and 15 equity country indexes.

He specifically used roll-adjusted front futures contracts to determine returns. In constructing carry portfolios, Baltas explored three different weighting schemes:

  • Cross-sectional carry: The relative strength of the carry of each asset compared to all other assets in the same asset class is used to construct a balanced long/short portfolio in terms of notional exposure.
  • Times-series/absolute carry: The sign of the carry of each asset is used to determine the type of position (long or short) to construct a portfolio with explicit directional tilts; net long when the majority of assets are in backwardation and net short when in contango.
  • Optimized (OPT) carry: Both the relative strength and the sign of the carry are used to determine the type of position (long or short) as well as the gross exposure for each asset. Most importantly, the optimized carry portfolio additionally accounts for the covariance structure between assets and asset classes in a way that risk allocation is optimized.

Following is a summary of Baltas’ findings: 

  • The correlations of the four carry strategies (commodities, bonds, currencies and equities) are all low to negative, providing strong diversification benefits while also minimizing the tail (or crash) risk generally associated with FX carry.
  • While FX carry exhibits negative skewness, equity market carry exhibits positive skewness.
  • Diversified carry strategies exhibit very low betas against various passive, broad market indexes (MSCI World Index, Bloomberg Commodity Index, JPMorgan Aggregate Bond Index and Trade-Weighted USD).
  • Carry strategies delivered statistically strong (at the 1% level of confidence) average excess returns (ranging from 5.9% to 9.1% at a targeted volatility of 7%) and generated high Sharpe ratios (ranging from 0.8 to 1.0).


Baltas concluded: “The greater benefit from extending carry to a multi-asset concept is, in fact, the diversification potential from combining carry strategies from different asset classes. The fact that not all carry strategies fail at the same time renders the multi-asset carry portfolio robust to equity downside risk and volatility spikes.”

When it comes to the implementation of this concept, the fund my firm, Buckingham Strategic Wealth, recommends the AQR Style Premia Alternative Fund (QSPRX), incorporates a multi-asset approach to the carry trade, allocating 14% of its exposure to carry in bonds, currencies and commodities.


Carry signals are found to have predictive power for future asset returns, not just within FX, but across commodities, equity indexes and government bonds. Thus, carry offers an additional, unique source of return for investors.

Importantly, diversified multi-asset class carry strategies do not appear to have a significant exposure to downside risk, either with respect to their respective markets or to the broad equity market. This makes carry attractive for inclusion in diversified portfolios.

For those interested in the academic research supporting logical, risk-based explanations for the carry premium, the chapter on carry in “Your Complete Guide to Factor-Based Investing” provides a summary. The explanations presented include a logical resolution to the uncovered interest parity puzzle of the FX carry trade.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.


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