Swedroe: Carry & Trend Effects Up Close

April 20, 2015

Two of the most well-known phenomena in investing are the carry effect and the trend effect. Trend is related to momentum. While carry is typically used in the context of currency markets (currencies with higher yields tend to produce higher returns than currencies with lower yields), it can also be employed in a broader context.


Specifically, assets such as stocks and bonds with higher yields produce higher returns, and commodities with lower futures prices (in backwardation) produce higher returns than commodities with higher futures prices (in contango). Thus, carry can be best thought of as the expected return on an asset, assuming that market conditions, including price, stay the same.


Vineer Bhansali, Josh Davis, Matthew Dorsten and Graham Rennison—authors of the March 2015 paper “Carry and Trend in Lots of Places”—studied four asset classes (stocks, bonds, commodities and currencies) across five different major country markets for a total of 20 sets of data. The study covered an extended sample period from 1960 to 2014.


Categorizing Assets

For each market, they categorize assets into one of four groups:

  1. positive carry and positive trend
  2. positive carry and negative trend
  3. negative carry and positive trend
  4. negative carry and negative trend


Their results “confirm overwhelmingly that having momentum and carry in your favor leads to significantly better returns, on both an absolute and a risk-adjusted basis.”


The following example, which is based on results for the U.S. 10-year Treasury note, clearly demonstrates how having both factors in your favor can improve investor outcomes. The authors found that “over the full sample, the average excess return for carry was 2.9 percent per year, but in periods when both trend and carry were in favor (i.e., positive), the average annualized excess return was almost double the average, at 5.2 percent per year.


Conversely, when both trend and carry were against the position, the average return was -4.2 percent. The mixed categories, with one of trend and carry against, and one in favor, the returns were in between, at 1.6 percent and 3.2 percent, respectively.”


Results ‘Robust’

The authors also found this result “appears remarkably robust across samples, including the period of rising interest rates from 1960 to 1982.” In particular, they found that “while carry predicts returns almost unconditionally, trend-following works far better when carry is in agreement.”


The authors add: “The results are striking and intuitive. In all but one case (Bund futures), the positive-carry, positive-trend buckets significantly outperform the negative-trend, negative-carry positions.”


A November 2013 study—“Carry,” by Ralph Koijen, Tobias Moskowitz, Lasse Pedersen and Evert Vrugt—found supporting results. For example, these authors found:

  • A carry trade that goes long high-carry assets and shorts low-carry assets earns significant returns in each asset class, with an annualized Sharpe ratio of 0.7 on average. Further, a diversified portfolio of carry strategies across all asset classes earns a Sharpe ratio of 1.1.
  • Carry predicts future returns in every asset class with a positive coefficient, but the magnitude of the predictive coefficient differs across asset classes.



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