Carry Strategies and the US Dollar Risk of US and Global Bonds

Abstract

In this article, the authors investigate the ability of currency carry strategies to mitigate the US-dollar risk of US and global bond benchmark indices. Using the Fama-French and currency factors, the authors analyze the bond benchmarks and find that currency carry strategies can easily be modified to suit bond investors, portfolio managers, and allocators. A central finding of the authors is that currency carry strategies help to mitigate the currency risk of the US dollar. Specifically, broad indices (including credit and government exposure) deserve modified carry strategies to mitigate the impact on the US dollar The results show that the exposure to the equity-based profitability factor—one of the factors in the Fama-French five-factor model—is to some extent a natural hedge against the US-dollar risk of high-yield and corporate indices. Moreover, combined currency carry overlay strategies and fixed-income investments generate Probabilistic Sharpe ratios above a certain threshold level. The results suggest that investors should consider modified currency carry strategies rather than simple carry rules when managing both US and global-high yield, corporate, and government debt. The authors also provide a framework that can be used to diversify the impact of individual equity-based factors and the currency style factors on fixed-income benchmarks.

TOPICS: Analysis of individual factors/risk premia, factor-based models, style investing

Key Findings

• • Carry strategies seek to reduce the US-dollar risk and improve the risk-return profile of US domestic and global fixed-income investments. The carry strategies can easily be implemented and monitored by portfolio managers and allocators desiring to control for their US-dollar risk.

• • Fixed-income adjusted currency carry strategies produce better results than the simple carry strategy as measured by the Probabilistic Sharpe ratio. Investors can utilize currency carry and manage the currency risk of corporate and high-yield US and global bond benchmarks.

• • Currency carry strategies generate diversified factor exposure to the Fama-French factors by mitigating the US-dollar risk and increasing alternative factor exposure.