Positive Carry Finance: Making Money While You Wait

In the world of finance, “positive carry” refers to a situation where the income generated from an investment exceeds the cost of financing it. Essentially, you’re getting paid to hold an asset. This contrasts with “negative carry,” where the financing costs outweigh the income, meaning you’re losing money while waiting for a potential price appreciation.

Understanding the Mechanics

The concept is relatively straightforward. Consider a simple example: You borrow money at a 5% interest rate to purchase a bond that yields 7%. The difference of 2% represents the positive carry. You’re earning more from the bond than you are paying in interest on the loan used to buy it.

This principle applies across various asset classes, including:

• Bonds: As in the example above, a positive carry occurs when the bond’s coupon rate is higher than the borrowing rate.
• Currencies: In forex trading, positive carry can be achieved through “carry trade” strategies. This involves borrowing a currency with a low interest rate and investing in a currency with a higher interest rate. The difference in interest rates represents the carry.
• Commodities: Holding physical commodities can generate a positive carry if the future price (determined by futures contracts) is higher than the spot price, a situation known as “contango”. This difference can help offset storage and insurance costs.
• Real Estate: A rental property generates positive carry if the rental income exceeds the mortgage payments, property taxes, and maintenance costs.

The Allure of Positive Carry

Positive carry strategies are attractive because they offer a source of income while you hold the asset. This income can cushion potential losses if the asset’s price declines. It also allows investors to potentially profit even if the asset’s price remains stable.

Furthermore, positive carry can provide a psychological advantage. Knowing that you are earning income on your investment, even small amounts, can make it easier to stay disciplined and avoid impulsive selling during market volatility.

Risks and Considerations

While appealing, positive carry is not without risk:

• Currency Risk: In carry trades, currency fluctuations can quickly erode profits. If the currency you’re invested in depreciates against the currency you borrowed, you could incur significant losses.
• Interest Rate Risk: Changes in interest rates can impact the profitability of positive carry strategies, especially for bonds.
• Counterparty Risk: Certain transactions might involve dealing with other parties, introducing the possibility of default or failure to honor commitments.
• Market Volatility: Unexpected market events can significantly impact asset prices, negating any positive carry benefits.

Moreover, focusing solely on positive carry can lead to neglecting other important factors, such as the underlying asset’s fundamental value and long-term prospects. It’s crucial to conduct thorough research and understand the risks involved before implementing any positive carry strategy.

Conclusion

Positive carry finance offers the potential to generate income while holding an asset. However, it is not a guaranteed path to profits and requires a deep understanding of the underlying asset, market dynamics, and associated risks. Used judiciously, positive carry strategies can be a valuable tool for income-oriented investors, but always remember to prioritize risk management and due diligence.