Combining positive carry and trend strategies is likely to deliver better-than-average absolute and risk-adjusted returns across asset classes and interest rate environments, according to PIMCO.
In a recent paper, the bond giant’s Vineer Bhansali, Josh Davis, Matt Dorsten, and Graham Rennison argued the two risk factors bring out the best in each other when used together.
“The best returns are when trend and carry are mutually reinforcing.”—PIMCOThe research defines carry as an annualized excess return assuming the price at which the future was bought stays the same. More generally, carry can also represent the expected return from holding an asset over a period of time, PIMCO said, while also taking into account its cost.
Trend-following strategies—similar to momentum—seek positive returns by taking advantage of market movements and the resulting changes in asset prices. The authors identified trend as positive if the future’s price today is above the one-year average price.
“While carry predicts returns almost unconditionally… positive trend strategies can match and even exceed positive carry strategies over a wide combination of periods and assets,” the report said. “The best returns are when trend and carry are mutually reinforcing.”
By studying returns for equities, bonds, currencies, and commodities futures from 1960 to 2014, the firm found positive carry and positive trend investments were the winning group.
For example, the average excess return for 10-year treasury note futures from 1972 to 2012 was 2.9% per year, according to PIMCO’s data. However, returns nearly doubled in periods when both trend and carry were positive, reaching an average excess return of 5.2% per year.
On the other hand, the average return dipped to a loss of 4.2% when both carry and trend were negative, the study found.
Furthermore, positive carry and trend grouping periods were most common for 10-year futures contracts from 1982 to 2012, consistent with the bull bond market during the time period.
“The best combination is to build portfolios that democratically harvest the best trend and best carry,” the authors said.
The pattern for outperformance was consistent for commodities, equities, and currencies, with just a few rare instances where negative carry and trend returns fared better.
PIMCO also said the positive carry and trend relationship triumphed during periods of rising interest rates.
Data from 1960 to December 1982 showed not only were annualized returns highest with the combination strategy, but also Sharpe ratios on average were above 1.3 across all four asset classes.
Read the full paper here.
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