Negative Carry

Negative carry occurs when the cost of holding an investment exceeds the income it produces over a given period. In other words, an investor pays more to maintain a position than they receive from it. Investors may accept negative carry when they expect capital gains or other benefits to outweigh ongoing carrying costs.

Key takeaways

• Negative carry means holding costs exceed income from an investment.
• Investors tolerate negative carry when they expect future capital appreciation or tax advantages.
• Negative carry can apply to bonds, stocks, real estate, forex positions, and even bank lending.

How negative carry works

Carry is the ongoing cost or return from holding an asset (interest, dividends, rent, etc.). If those holding costs are higher than the income the asset generates, the position has negative carry. This calculation typically excludes any potential capital gains or losses realized when the asset is sold.

Common sources of carry cost:
* Interest paid on borrowed funds used to buy the asset.
* Maintenance, taxes, and insurance for real estate.
* Dividend or financing costs for short positions.

Investors initiate or maintain negative-carry positions when they expect price appreciation, favorable exchange-rate moves, or tax benefits that will offset the ongoing costs.

Examples

Real estate

Owner-occupied homes and some rental properties can have negative carry. Early in a mortgage timeline, interest payments often exceed principal reduction, and upkeep and taxes add expenses. Owners accept these costs with the expectation of long-term capital appreciation.

Borrowing to invest (bonds and other assets)

If an investor borrows at 6% to buy a bond yielding 4%, the position has a 2% negative carry. The investor will lose money on carry unless the bond’s price rises (for example, if market interest rates fall), producing capital gains that more than offset the interest cost.

Forex (negative carry pairs)

A negative carry forex trade involves borrowing in a high-interest-rate currency and investing in a low-interest-rate currency. If the low-rate currency appreciates against the high-rate currency, exchange-rate gains can overcome the interest cost. This is essentially the reverse of a traditional carry trade.

Short selling

Short positions can produce negative carry when the costs of borrowing stock, paying dividends, or financing the short exceed any returns from the position. In market-neutral strategies, pairing shorts with longs can still create net negative carry.

Special considerations

• Tax benefits: Deductible interest or other tax treatments can reduce net cost of carry, making negative-carry investments more attractive depending on jurisdiction and rules.
• Risk: Holding a negative carry position requires the anticipated gains to materialize; otherwise the investor suffers ongoing losses.
• Timing and liquidity: The longer negative carry is paid without realizing gains, the greater the drag on returns. Liquidity constraints or adverse market moves can force exit at a loss.

Negative carry vs. positive carry

• Positive carry: Income from an asset (interest, dividend, rent) exceeds the cost of holding it; the position generates net cash flow while held.
• Negative carry: Holding costs exceed income; the position requires ongoing funding or reduces overall returns until or unless capital appreciation or other benefits compensate.

Conclusion

Negative carry is a common feature of many investment strategies. It becomes justified when expected capital gains, currency moves, or tax effects are likely to offset the ongoing costs. Investors should weigh the probability and magnitude of those future benefits against the steady drain of carrying costs and the associated risks.