Advanced Carry Trade Strategies go beyond the traditional approach of borrowing in low-yielding currencies and investing in high-yielding ones. These strategies incorporate more sophisticated elements such as volatility management, macroeconomic analysis, momentum signals, and dynamic risk controls. By combining carry with systematic execution and global macro forecasting, these strategies aim to deliver higher risk-adjusted returns and improved consistency.

This article will dive into the different types of advanced carry strategies used by institutional traders and how they are structured to outperform traditional carry trades by considering factors like volatility, regime shifts, and macroeconomic cycles.

Why Use Advanced Carry Trade Strategies?

• Traditional carry trade vulnerabilities: High-yielding currencies are often volatile and prone to sudden devaluation.
• Macro environments matter: Interest rate differentials alone aren’t enough—market cycles, volatility regimes, and central bank policies should guide exposure.
• Increased efficiency: Advanced carry strategies can improve risk-adjusted returns by avoiding carry traps during market stress.

By using a more sophisticated approach, traders can optimise returns while managing downside risk more effectively than traditional models.

Core Types of Advanced Carry Trade Strategies

1. Risk-Adjusted Carry Trade

• This strategy prioritises the carry-to-risk ratio, meaning it combines yield with volatility analysis.
• Currencies are ranked not just by their interest rate differential but by their volatility and drawdown history.
• Positions are sized inversely to volatility, meaning larger allocations to low-volatility currencies and smaller positions in volatile high-carry pairs.

Example:
Instead of solely going long MXN/JPY (due to high carry), the strategy would size the position based on the volatility of the pair—allocating more to AUD/JPY, which has a more stable volatility profile.

2. Momentum-Based Carry Strategy

• This strategy combines carry with momentum. It only takes on carry positions that are trending in the direction of the currency.
• Momentum filters are applied to capture currencies with both positive carry and bullish price trends.
• It avoids pairing high-yield currencies with negative momentum, which could result in a reversal that erodes carry gains.

Example:
If EUR/JPY is offering high yield but the currency is trending lower, it would be removed from the carry basket, and other positively trending currencies with strong carry would be favoured.

3. Volatility-Adjusted Carry Strategy

• This strategy adjusts carry exposures based on implied and realised volatility.
• Volatility-adjusted position sizing ensures that traders do not overexpose themselves to high-yield but high-volatility pairs.
• The strategy is designed to enhance risk-adjusted returns by trading currencies that offer good carry relative to their volatility profile.

Strategy example:
If EUR/USD offers good carry but experiences high volatility, the strategy may opt to reduce the position or shift to a lower-volatility pair with a better risk-to-reward ratio.

4. Macro-Driven Carry Allocation

• This strategy incorporates macroeconomic analysis to allocate carry trades based on the prevailing economic conditions.
• It dynamically adjusts the carry portfolio based on economic indicators such as GDP growth, inflation rates, central bank policies, and capital flows.
• This strategy optimises carry exposure by focusing on countries with strong economic fundamentals and diverging central bank policies.

Example:
Long USD/JPY when the Fed is tightening and the BoJ is dovish, while reducing carry exposure in markets with high inflation or economic slowdown (e.g., certain EM currencies).

5. Multi-Layered Carry Trade

• This strategy combines FX carry, bond carry, equity dividend yield, and even volatility premium into a single portfolio.
• It aims to diversify across asset classes, ensuring that carry returns are not solely dependent on FX movements, but also on fixed income, equity, and volatility positioning.
• The multi-layered approach reduces risk and enhances returns by creating an integrated carry portfolio.

Example:
Long MXN/JPY for FX carry, Brazilian bonds for bond carry, and long S&P 500 dividend futures for equity yield. Volatility exposure may be hedged via long VIX futures or options.

6. Machine Learning Enhanced Carry Strategy

• Using machine learning (ML) models, this strategy forecasts the future performance of carry trades by analyzing a variety of economic indicators, historical data, and market sentiment.
• The models can automatically identify patterns and market regimes where traditional carry trades perform best, adjusting the portfolio dynamically in response to new data.
• This approach also helps in selecting carry pairs that might otherwise go unnoticed by traditional models.

Use case:
A machine learning model might highlight that historically, carry trades involving AUD/USD perform better during global growth periods when PMI readings are above 50. This insight would guide capital allocation to favour AUD/USD during such periods.

7. Tail-Hedged Carry Trades

• This strategy involves hedging tail risk in carry trades using deep out-of-the-money options or other hedging instruments to protect against sharp reversals or currency crises.
• The goal is to maintain exposure to high-yielding currencies while limiting potential downside during periods of extreme market stress.

Strategy logic:
Long BRL/CHF (high yield) and hedge with long USD/JPY calls during periods of high uncertainty, such as before major geopolitical events or central bank policy shifts.

8. Cross-Asset Carry Trade

• This advanced strategy extends carry trading across asset classes, allowing for more diversified and robust returns.
• It may involve trading in FX, bonds, commodities, and equities simultaneously.
• The strategy seeks to profit from carry differentials in multiple asset classes and is more adaptable to changing market regimes.

Example:
Long oil futures in backwardation (positive carry) while simultaneously holding short positions in bond futures with low yields. Combine with an FX carry basket focused on stable high-yield currencies.

Key Risk Management Techniques for Advanced Carry Strategies

Risk	Mitigation
Volatility spikes	Use volatility filters to reduce position sizing during high volatility
Sudden policy changes	Stay updated on central bank guidance and implement dynamic hedging
Large market moves	Hedge with options, NDFs, or FX options to protect against adverse price moves
Illiquidity in high-carry currencies	Avoid high-concentration in currencies with low market liquidity or extreme volatility

Advantages of Advanced Carry Strategies

• Diversified risk sources: Reduces reliance on any single market or currency.
• Improved risk-adjusted returns: By managing volatility, drawdown, and liquidity risk.
• Adaptability: Adjusts to changing economic cycles, volatility regimes, and global risk sentiment.
• Higher consistency: Outperforms traditional carry during volatile or uncertain market conditions.

Conclusion

Advanced Carry Trade Strategies represent a significant improvement over the traditional carry approach by incorporating risk-adjusted techniques, volatility management, and macroeconomic insights. These strategies offer more reliable returns, better protection during stress periods, and the flexibility to adapt to shifting market conditions.

To master these advanced carry models, portfolio construction, and risk management techniques, enrol in our expert-led Trading Courses designed for macro traders, institutional investors, and cross-asset portfolio managers.