What it means
The carry of an investment is the income it generates minus the cost of holding it, which usually means the interest paid on borrowed money. When the income exceeds the cost, the carry is positive and the holder is paid to wait.
When the cost is greater, the carry is negative and the holder is paying to wait. The idea is common in currency, bond and commodity markets.
A trader who borrows in a currency with a high interest rate to buy a currency with a low rate has negative carry, and a trader who stores physical commodities pays for storage and financing without receiving any income. Negative carry is not always a mistake.
An investor may accept it because they expect the price to rise by more than the running cost, and a business might hold a long-term asset such as land at a negative carry because of strategic value. The question is whether the expected gain justifies the cost.
For business readers, the concept shows up in treasury and investment decisions. A company that borrows at 6% and parks the money in cash earning 3% is paying for the privilege, and a firm that keeps expensive debt while holding large idle cash balances has negative carry on the difference.
Several nuances matter. Carry changes as interest rates move, so a position can flip from positive to negative, and the cost of a margin loan or repo (a short-term loan secured against securities) may reset frequently.
Taxes, fees and exchange rates can also change the true picture. Investors often compare carry with the expected price movement over the same time.
The breakeven price rise is simply the total carry cost divided by the amount invested, and the position needs the price to rise by more than that to be profitable.
In practice
Real-world examples.
Example
A hedge fund borrows in one currency at 5% to buy bonds in another currency that pay 3%. It accepts a loss each month in return for an expected rise in the exchange rate.
Example
A property developer holds an undeveloped plot financed by a 7% loan. The land earns no income, so the interest of $70,000 a year on a $1,000,000 loan is a negative carry until the land is built on or sold.
Example
A corporate treasurer notices that her company holds $20,000,000 in cash earning 2% while its revolving credit facility costs 6%. She uses some of the cash to repay the facility, which removes the negative carry.
Formula
Calculation
Net carry = Income earned from the asset - Cost of financing the asset
Worked example: an investor borrows $1,000,000 at 5% a year to buy bonds that yield 3% a year.
Income = $1,000,000 x 0.03 = $30,000
Financing cost = $1,000,000 x 0.05 = $50,000
Net carry = $30,000 - $50,000 = -$20,000 a year, or -2% of the amount invested.
The bonds must rise in price by at least 2% over the year, which is $20,000, just to break even.
If the bonds rise by 5% to be worth $1,050,000, the profit is $50,000 - $20,000 = $30,000.Case study
Seen in the real world.
Meridian Holdings is an illustrative, fictional investment company that bought a portfolio of long-dated bonds yielding 3.5% using borrowed money at 4.5%. The investment team expected interest rates to fall, which would raise the bond prices and more than pay for the cost of waiting.
For the first six months, the portfolio lost money on a carry basis, a cost of around $250,000 on the $50,000,000 position. Rates did not fall as expected, and the finance director pressed for a decision about whether to keep the trade or close it.
The team decided to cut the position in half and use the remaining half only until a specific date. In this illustrative story, the main lesson was that carry is a certain, regular cost, while the expected price gain is only a forecast, so the size of the trade should reflect that uncertainty.
Watch out
Common mistakes.
- Ignoring the financing cost when judging whether an investment is earning its keep.
- Assuming the carry will stay the same, when rates and spreads can change.
- Treating negative carry as always bad, when it can be a deliberate cost paid for a price view.
Questions
People also ask.
What is the opposite of negative carry?
Positive carry, where the income from holding the asset exceeds the cost of financing it.
Does negative carry only apply to borrowed money?
No, it also applies when the opportunity cost of using your own funds exceeds the income the asset produces.
How do you offset negative carry?
You can reduce the borrowing, switch to a higher-yielding asset, shorten the holding period or hedge the position.
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