Negative Carry

At The Money (ATM)

What is negative carry?

Negative carry is a condition in which the cost of holding an investment or security exceeds the income earned by holding it. A carry trade or negative investment is often undesirable for professional portfolio managers as it means that the investment loses money as long as the main value of the investment remains the same (or decreases). However, many investors and professionals regularly enter such conditions where they expect a significant gain in holding the investment over time.

Key points to remember

  • Negative carry is a condition in which investments cost more than they bring in the short term.
  • There may be many reasons to keep the investment, but they all include the concept of anticipated capital gains.
  • Negative carry can exist on a wide variety of investments.

How negative porting works

Any investment whose holding costs more than it pays in payments can lead to negative carry. A negative carry investment can be a securities position (such as bonds, stocks, futures or foreign exchange positions), real estate (such as rental property) or even a business. Even banks can experience negative carry if the income from a loan is less than the cost of bank funds. This is also called the negative cost of carrying.

This measure does not include capital gains that could occur when the asset is sold or matures. These anticipated gains are often the main reason why negative investments of this nature are initiated and held.

For example, owning a home is a negative investment for most homeowners who live there as their primary residence. The cost of interest on a typical mortgage each month is greater than the amount that will accrue to the principal during the first half of the term of the mortgage. In addition, the cost of home maintenance is also a financial burden. However, since home prices have tended to rise over the years, many homeowners experience at least some capital gain by owning the home for at least a few years.

In the world of professional investment, an investor can borrow money with interest of 6% to invest in a bond paying a return of 4%. In this case, the investor has a negative carry of 2% and actually spends money to own the bond. The only reason for this would be that the bond was purchased at a discount from expected future prices. If the bond has been purchased at par or above and held until maturity, the investor will have a negative return. However, if the price of the bond rises (which happens when interest rates fall), the investor’s capital gains may well outweigh the negative carry loss.

Another reason to buy a negative carryforward investment may be to take advantage of tax benefits. For example, suppose an investor bought a condominium and rented it after all the expenses were added to the rental income, which is $ 50 less than the monthly expenses. However, since the interest payment was tax deductible, the investor saved $ 150 a month in taxes. This allows the investor to keep the condo long enough to anticipate capital gains. Since tax laws vary from one to another, these benefits will not be uniform everywhere, and when tax laws change, the cost of carry may become higher.

While borrowing to invest is the typical reason for a negative carry (where the cost of carry is the interest), short selling can also create a negative carry situation. An example would be in a market neutral strategy where a short position in one security is compared to a long position in another.

Investors in the foreign exchange markets may also have a negative carry trade, called a negative carry pair. Borrowing money in a currency with high interest rates and then investing in assets denominated in a currency with lower interest rates will cause negative carry. However, if the value of the high-yielding currency decreases relative to the lower-yielding currency, the favorable change in exchange rates can generate profits that more than offset the negative carry.

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