Carry On Wayward Son

A Cliff Clavin footnote to start is that the Kansas song is called Carry on Wayward Son, not my wayward son, obviously the lyrics include the word my but not the title. 

The ReturnStacked US Stocks & Futures Yield ETF (RSSY) starts trading on the CBOE on Wednesday. We've taken a couple of looks at carry as an investment strategy and hopefully we can dig in a little deeper to learn more. RSSY stacks carry on top of equities using leverage. 

The first thing you might think of for a carry trade is a long/short trade, going long high yielding currencies and shorting lower yielding currencies. That trade can capture the spread in yield and maybe some positive basis points of return with the idea being that higher yielding currencies are preferable to lower yielding currencies. It doesn't always work that way of course but that is the idea.

That sort of long/short has been applied to other concepts like arbitrage and managed futures. Carry as a term has also been applied to futures curves going long futures where rolling to future contracts can be done profitably (backwardation) and short futures where rolling forward is more expensive (contango). 

There seems to be some overlap with managed futures, going long and short various futures but managed futures looks at trend, usually 10 month/200 day trends whereas as carry is more about exploiting term structure. 

Finomial took a closer look at the comparison between managed futures and carry and for their money, managed futures is the more effective portfolio diversifier. They might be correct but there are some nits to pick with their blog post. The context of carry in the post seems to just be long high yielding currencies/short low yielding currencies. They mention that managed futures has outperformed carry as follows.

They note however that carry tends to do better with higher interest rates. We had very low interest rates for ages and carry traded sideways for the most part. The carry index does appear to start moving higher in late 2022 or early 2023 as the effect of higher rates started to kick in. Maybe it can do better now that rates are higher? The chart also shows that carry has not helped as crisis alpha in either 2008 when it dropped dramatically or in 2022 where it looked like a horizonal line with a slight tilt upwards. 

In a post looking at carry earlier this month I used Vanguard Market Neutral (VMNIX) as a proxy for carry. I'm not aware of any funds that just focus on carry but VMNIX looked like a reasonable proxy after playing around with some currency carry trades. I think the chart above also shows that merger arbitrage or convertible arbitrage might also be proxies for carry. 

The new RSSY ETF looks like it will focus on carry as applied to roll yield dynamics. I am not aware of a way to back test it with another fund. In their presentation for the fund they provide some information. 

No correlation to stocks or bonds is not a bad thing when allocated in small doses. Stocks being the thing that goes up the most, most of the time, most investors shouldn't be too far away from a "normal" allocation to stocks but small exposures to uncorrelated return streams as carry might be can help smooth out the ride. Similar to the cross currency version, the roll yield carry strategy went up slightly in 2022. I said it wasn't crisis alpha but let me know if you disagree. The futures yield line looks very absolute-returnish.

Despite the conceptual overlap between managed futures and futures yield, they appear to be different types of return streams and so I don't think the comparison Finomial is making is the right thing to study. Alternatives that are better suited to compare are arbitrages as I mentioned above and anything else that looks like a horizontal line that tilts upward. 

Carry is also applied to the yield on an instrument, irrespective of price movement. If a long term bond yields 5%, the price might be very volatile but it will still pay that 5% until maturity...probably. I had a thought about how to apply a carry-ish strategy to the extremely high "yielding" covered call ETFs related to the person who had to retire early and start living off their portfolio sooner. This could be a way to slightly stretch a portfolio's yield until Social Security kicks in. 

YieldMax was an early mover in this space with mostly single stock, covered call funds but also a few that have exposure to multiple stocks including the YieldMax Universe Fund of Option Income ETFs (YMAX). For purposes of this study, I wouldn't use a single stock YieldMax because it would be too easy to use one that is "working" like Nvidia and avoid one that is floundering like Tesla. The fortunes of those two could switch at anytime. I calculate the trailing "yield" for YMAX at 27%. Assuming that's right, my thought is to allocate enough to it to generate 1% for the entire portfolio. If 27% is correct, then I get a 3.7% weighting to YMAX to account for 1% for a portfolio's total yield. 

The 27% "yield" isn't static of course but how much yield and growth could could be had with the other 96.3% of the portfolio? Putting 57.78 into an S&P 500 fund and 38.52 into the SPDR T-Bill ETF (BIL) which is proportionally correct for 60/40 after putting 3.7% into a high yielding covered call fund at the start of 2022. That would be a very unlucky starting period resulted in 1.97% CAGR not including dividends. The total return was 4.13% annualized plus the theoretical 1% from the covered call fund with that very unfavorable starting point. Looking from 2023 onward would be more favorable because T-bills yielded 5% all of that year and stocks went up in 2023. 

Really I'm just fumbling around with this idea. What I think would happen is that the rest of the portfolio would more than make up for possible erosion of the covered call ETF. I believe I have the cred to build the example using T-bills and not an aggregate bond index because I've been saying to avoid or greatly minimize exposure to duration for many years. 

If that idea isn't crazy enough, GraniteShares has filed for a suite of funds that will own 2x single stock ETFs and sell calls against them and funds that will own 3x index ETFs like the Direxion Daily 3x Bull S&P 500 ETF) SPXL and sell calls against those. I'll try to dig in on them if they ever see the light of day. 

Closing out on carry, I am of course curious to see what RSSY does but I am not convinced it offers a differentiated attribute, differentiated from other strategies that offer a similar return and volatility profile that have longer track records in fund form. RSSY did trade over 5 million shares on its first day so someone certainly has confidence in it. Congrats to the ReturnStacked guys for a great first day.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.