×

Currency Carry Trade 'Carries' Investors to Losses

NYSE Trader
Photo: Oliver Quillia for CNBC.com
NYSE Trader

"Currency traders that seek profits by borrowing in nations with low interest rates to fund purchases in countries with higher yields are losing more money than at any time in at least a decade."

So begins a Bloomberg News story, dated yesterday.

When I took my first job at an investment bank many years ago I didn't know anything.

It was back in those early years that I first heard the term 'carry trade'. I remember that when I first heard the concept it sounded like the most romantic and mysterious thing in the world.

Like I said, I didn't know anything.

Back then I was humble and inquisitive: So I asked a trader about how it worked.

Needless to say, I didn't quite understand the answer I got.

I was told something that sounded very complicated: And I came away with a vague understanding that the carry trade had something to do with borrowing funds in a currency with low interest rates, and then buying assets in markets with higher returns.

Brilliant, I thought.

I remember thinking it all sounded so cool and international—a way for guys who were far smarter than I was to make tons of money in ways I couldn't understand.

(Note: In those days, if a bank was losing money on every trade it executed, I could have been convinced—by a clever enough flack—that the bank could make up for the losses by simply trading more volume.)

What I didn't understand then was that a carry trade doubles down your risk on every bet.

You stand to lose money the moment you flip your dollars into a foreign currency. And then you stand to lose more money again on whatever assets you subsequently buy.

But the truth is that a carry trade just sounds cool—and I don't think that's an immaterial point.

Anyone who runs money will tell you that a good story hooks investors.

People love to pour cash into things that sound clever, sophisticated, and international.

Once again, from Bloomberg:

"The strategy lost 2.5 percent in 2010 as the dollar—a favorite for financing the trades because of record low U.S. rates—appreciated, according to an index compiled by UBS AG, the world's second-largest foreign-exchange trader. That's more than the 0.98 percent drop in 2008 when the collapse of Lehman Brothers Holdings Inc. caused credit markets to freeze and the worst performance for so-called carry trades since at least 1999 when UBS began releasing yearly figures."

Sure, you may lose some money on the trade.

But what the heck: Investors got back, on average, 97.5 percent of their money — which is better than you can say for CDO's.

Besides, the carry trade is a great story to tell on a golf course.

_________________________________________________

Questions? Comments? Email us atNetNet@cnbc.com

Follow NetNet on Twitter @ twitter.com/CNBCnetnet

Facebook us @ www.facebook.com/NetNetCNBC