Carry versus Trend Following

Which one will carry you further?

May 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • The carry strategy has become more attractive given higher yields
  • However, the strategy is highly correlated to equities in periods of market stress
  • CTAs are better diversifiers

INTRODUCTION

Carry strategies were widely popular before the global financial crisis in 2009, but less thereafter given a substantial drawdown during the crisis when investors reversed their positions and fled to safe but low-yielding currencies like the USD or CHF.

Although the carry strategy recovered in 2010 and 2011, investors’ interest remained muted in the following decade. Partially we can attribute the limited interest to a lack of performance, which in turn can be explained by the low-interest rate environment that made betting on the spread between high yielding and low yielding currencies less attractive.

However, this changed in 2022 when central banks started raising interest rates and the spread widened again as central bank policies were not synchronous across the globe.

Another strategy, namely trend following funds, also called CTAs or managed futures strategies, similarly suffered from little interest in the decade post the GFC, despite having performed strongly during the crisis (Managed Futures: The Empire Strikes Back).

Many asset managers combine these two strategies and such a combination has even become available as an ETF via JP Morgan’s Managed Futures UCITS ETF, albeit only for a brief period between 2017 and 2020 when the product was liquidated due to poor performance.

In this research note, we will contrast the carry versus trend following strategies.

PERFORMANCE OF CARRY VERSUS CTAS

We will use two indices from Societe Generale as proxies for the carry trade and trend following strategy. The carry trade can be implemented across asset classes, but is most established in currencies where investors buy the highest and short the lowest yielding currencies. The SG FX G10 Carry Index represents a portfolio of long positions in the three currencies with the highest yield and short positions in the three