In financial markets, the pursuit of strategies that consistently generate returns is a perpetual endeavor. The paper “Carry” by Koijen, Moskowitz, Pedersen, and Vrugt provides a comprehensive examination of the carry trade across various asset classes, establishing a unified framework that extends beyond traditional applications. The authors redefine carry as the expected return of an asset assuming its price remains constant, effectively capturing the yield or income component inherent in holding the asset. This approach allows for a consistent application of the carry concept across currencies, commodities, equities, and fixed income.

By focusing on futures or synthetic futures where necessary, the authors measure carry as the difference between the futures price and the spot price of an asset. This methodology simplifies the comparison across asset classes and eliminates issues related to storage costs, dividend yields, or interest rate differentials that can complicate carry calculations in specific markets. The paper’s motivation lies in testing whether carry, as they define it, serves as a robust predictor of returns across a broad spectrum of assets, challenging traditional theories like the Uncovered Interest Rate Parity (UIP) and the Expectations Hypothesis (EH).

Fig. 1. The cumulative sum of excess returns for the global carry factor (GCF) across all asset classes and for a currency-only carry strategy. Each asset class’s carry portfolio is weighted to contribute equally to the total volatility of the diversified portfolio. The sample period is from 1983 to 2012.

Figure 1 illustrates the cumulative returns of the global carry factor (GCF) compared to a currency-only carry strategy. The GCF consistently outperforms, highlighting the advantages of applying carry strategies across multiple asset classes. The diversified approach not only enhances returns but also reduces volatility, showcasing the potential for carry strategies to contribute meaningfully to a portfolio’s performance.

Further analysis in the paper examines the relationship between carry and expected returns. The authors find that carry is a significant predictor of future returns across most asset classes. Notably, in equities and fixed income, the predictive power of carry is particularly strong, implying that assets with higher carry tend to experience both higher yields and price appreciation.

Fig. 2. For each asset class, the cumulative excess returns of the long-short carry portfolio are plotted alongside the cumulative carry. The difference between the return and the carry represents the realized price appreciation or depreciation. The sample period is from 1972 to 2012.

Figure 2 provides a deeper dive into individual asset classes, comparing cumulative returns to cumulative carry. The analysis reveals varying dynamics across markets. For equities, cumulative returns exceed cumulative carry, indicating price appreciation contributes to the overall returns. In contrast, commodities often show cumulative returns lagging behind cumulative carry, suggesting that price movements can offset some of the yield earned from carry.

The insights from this paper have significant implications for investors employing return stacking strategies. By demonstrating that carry is a consistent and robust predictor of returns across asset classes, the authors provide a strong case for integrating carry strategies into diversified portfolios. Return stacking aims to enhance portfolio returns by combining multiple return streams, often through strategies like portable alpha and trend following.

Incorporating carry strategies can potentially improve the capital efficiency of a portfolio. Since carry returns are not fully explained by traditional risk factors, they offer an additional source of returns that can complement existing strategies. The high Sharpe ratios and diversification benefits identified in the paper suggest that carry strategies can enhance risk-adjusted returns when included in a return stacked portfolio.

Moreover, understanding the conditions under which carry strategies perform well or face challenges enables investors to better manage risk. For instance, during periods of market stress or heightened volatility, carry strategies may underperform. By combining carry with other strategies that may perform differently under such conditions, investors can build more resilient portfolios.

Koijen et al.’s paper “Carry” provides a pivotal contribution to the understanding of carry trades across financial markets. By formulating a unified definition of carry and empirically testing its predictive power across asset classes, the authors demonstrate that carry is a significant and pervasive driver of returns. The findings underscore the potential for carry strategies to enhance portfolio performance, especially when applied in a diversified, global context.

For investors employing return stacking strategies, integrating carry offers an opportunity to access an additional return stream that is both uncorrelated with traditional risk factors and complementary to other strategies like trend following or portable alpha. The paper’s insights into the risk and return characteristics of carry trades empower investors to construct more efficient and resilient portfolios, aligning with the evolving landscape of portfolio construction and the pursuit of superior risk-adjusted returns.