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This summary gives a practitioner’s summary on the article “Carry Investing on the Yield Curve,” by Martin Martens, Paul Beekhuizen, Johan Duyvesteyn, CFA, and Casper Zomerdijk, CFA, published in the Fourth Quarter 2019 issue of the Financial Analysts Journal.
What’s the Investment Issue?
The carry of a government bond is the return on investment if the yield curve doesn’t change. Exploiting curve carry as a strategy for bond investing involves buying high carry bonds and selling low carry bonds.
The authors investigate the profits to global curve carry strategies and their relationship with “betting against beta” (BAB)—a curve strategy that buys short-maturity government bonds and sells longer maturities.
Their approach is also compared with other well-known strategies—namely, momentum, value, and single-country carry.
How Do the Authors Tackle the Issue?
The authors sort the government bonds of 13 developed markets into six maturity buckets, ranging from short to long term. The 13 markets are Australia, Belgium, Canada, Denmark, France, Germany, Italy, Japan, the Netherlands, Spain, Sweden, the United Kingdom, and the United States.
Previous research on carry has been based on individual bonds. The authors’ curve carry strategy buys multiple bonds within the maturity buckets, going long bonds with a high carry in each of the countries and selling low carry maturities in each.
They apply the same investment process across the 13 selected countries to create what they call a “global carry factor.” They then compare the returns, risk, and volatility of this global carry factor with those of the country carry factor, BAB, value factor, and momentum factor strategies.
What Are the Findings?
For the global carry factor, the information ratio—a measure of the risk-adjusted return of the portfolio—is 1.0, suggesting strong potential for excess returns above the benchmark. A portfolio of long-only government bond positions based on the global carry strategy outperformed the J.P. Morgan Global Government Bond Index (JPM GBI) by 1.37% a year after transaction costs.
The excess returns are not, the authors contend, due to country carry, momentum, value, or BAB. The entire 10 bps of return a year from the BAB strategy is attributable to carry. After subsuming BAB exposure, global curve carry alpha is still some 20 bps a year.
The global strategy also has strong diversification benefits: The correlations between curve carry strategies across the 13 countries are low, and volatility is just 0.24% a year, considerably lower than the average volatility in each country.
What Are the Implications for Investors and Investment Managers?
Global carry can be considered a new bond factor since its excess returns are in addition to known and widely used bond factors.
There are several reasons to use global carry when investing in government bonds. First, the risk–return trade-off is compelling; global carry is better at predicting bond returns because it is a forward-looking measure, driven by current yield levels. Other factors are backward looking, depending on past yields.
Second, global curve carry returns have low correlation with those of other bond factors. Third, correlation between curve carry strategies in different countries is low, providing diversification benefits.
A government bond portfolio based on global curve carry could, argue the authors, be considered a smart version of the BAB strategy.