Organizing knowledge is vital. I would argue that the transition from data to information is caused by organization. Before the periodic table, chemistry was just a collection of unrelated observations. Before the unifying principle of evolution through natural selection, most of biology made no sense. Categories and frameworks are more helpful than a bunch of disconnected facts.

At Hull Tactical, our guiding philosophy is to combine many micro-alphas into a single signal. We embrace the diversity and complexity of signals rather than look for a single, silver bullet.

But as rational investors we know that there are other unifying ideas we can consider as well, and one of these is carry. Carry is the cost incurred or income received for holding a position, assuming that no price changes occur.

In the paper, “Carry,” Ralph Koijen, Tobias Moskowitz, Lasse Pedersen, and Evert Vrugt investigate expected return in several asset classes as a functions of carry and price change. They looked at equities, bonds, currencies, commodities, and index options. Additionally, they divided carry into two parts: passive and dynamic. Passive carry refers to the income from holding a position and dynamic carry is how well carry predicts future price changes. Using data from 1972 through to 2012 they concluded:

• Carry returns and total returns are positively correlated.
• Carry is correlated with value in equities. (This makes sense as equity carry is realized through dividends and high dividends are a classic measure of value.)
• Carry is correlated with momentum in bonds and commodities.
• Carry performs poorly during recessions. (This is to be expected given its relationship to value and momentum.)
• Most of the positive returns are due to the ability of carry to predict price appreciation (dynamic carry).

We believe it is intuitively obvious that carry is a good thing in that we receive money (dividends, coupons, interest) just for holding a position, but it is even better that it predicts price appreciation.

Our model currently has six factors that are forms of carry (dividend yield and various interest rate factors) but they got into our model as a bottom-up process where we found, tested and integrated each separately. Carry is a top-down approach, but it might be the ultimate explanatory market principle.

Disclaimer

This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the proposals and services described herein, any risks associated therewith and any related legal, tax, accounting, or other material considerations. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to their specific portfolio or situation, prospective investors are encouraged to contact HTAA or consult with the professional advisor of their choosing.

Except where otherwise indicated, the information contained in this article is based on matters as they exist as of the date of preparation of such material and not as of the date of distribution of any future date. Recipients should not rely on this material in making any future investment decision.