Factor Carry & Relative Value: The Equity-Native Version of the Carry Trade

Georgi Kuzmanov Senior Equity Analyst & Founder Columbia MSFE · 13+ years equity research

The most famous trade in macro is the carry trade: borrow a low-yielding currency, hold a high-yielding one, and pocket the interest-rate difference for as long as exchange rates behave. You are, quite literally, paid to wait. It works for years and then, in a violent unwind, gives much of it back at once — carry is a risk premium, not free money.

We do not trade currencies. But the structure of the carry trade — earn a yield differential for bearing a risk that shows up rarely and all at once — has a clean equity-native analog, and it is one our engine actually harvests. Instead of an interest-rate spread across currencies, we harvest a cash-flow yield spread across stocks: get paid, in free cash flow and buybacks, to hold cheap and shareholder-friendly companies, funded by shorting expensive ones that pay you nothing. The vineyard in the hero image is the honest metaphor — an asset that hands you a harvest every year you are willing to hold it, in good years and lean ones alike.

This is the sixth article in our Macro & Strategy series and the second on alpha generation, after cross-sectional momentum. By the end you will have the FX-to-equity mapping stated precisely, the exact cash-flow-yield factor definitions our engine ranks on, the size of the carry spread we measured on our own data, and the three things that make this a risk premium rather than a free lunch: the droughts, the value traps, and the cost of the short.

What “Carry” Means, From FX to Equities

Carry, generally, is the return you earn simply for holding an asset, before any price change. For a bond it is the coupon; for a currency it is the interest-rate differential; for a physical commodity it is negative (you pay to store it). For equities the natural carry is the cash the business throws off to its owners — free cash flow and net buybacks — expressed as a yield on what you pay to own it.

The mapping has to be stated honestly, because the two trades are cousins, not twins:

Both are, at bottom, relative-value trades: you are not betting the whole asset class goes up, you are betting the cheap members outperform the expensive ones. And both are compensated for a specific discomfort — in FX, the occasional currency crash; in equities, the periodic regime where expensive growth stocks keep getting more expensive and cheap stays cheap. That discomfort is exactly why the premium exists and does not get arbitraged away.

It is worth being clear about why free cash flow, specifically, rather than the earnings yield or book-to-market ratio that older value literature leans on. Reported earnings are an accountant’s opinion — shaped by depreciation schedules, accruals, and one-time charges — while cash from operations is closer to a fact: it is money that actually arrived. Book value, meanwhile, has slowly decoupled from economic worth as the market has tilted toward asset-light businesses whose value lives in intangibles the balance sheet never records. Yielding on cash flow sidesteps both problems, which is why our carry factors measure what the business pays rather than what it reports or what it once cost.

The Formula: Cash-Flow Yield and the Carry Spread

Our two carry factors are yields with deliberately chosen denominators:

FCF/EV(i) = freeCashFlow(i) / enterpriseValue(i)
   where enterpriseValue = marketCap + debt − cash

buyback_yield(i) = −netCommonStockIssuance(i) / marketCap(i)
   ( positive when the firm is buying back stock )

carry spread = mean(top-decile yield) − mean(bottom-decile yield)

The denominator on FCF/EV is the important detail. Yielding free cash flow against enterprise value — which adds debt and subtracts cash — rather than against market cap means a company cannot look cheap merely by piling on leverage. It is the difference between asking “what does the equity cost?” and “what does the whole business cost to acquire, debt and all?” The second question is the one a private buyer would ask, and it is much harder to game.

The Implementation: The Real Factor Definitions

These are not textbook idealizations — they are the exact lines our live long/short composite ranks on, straight from the factor library:

def _factor_frames(P):
    A  = P['assets']
    ev = (P['marketcap'].fillna(0) + P['debt'].fillna(0)
          - P['cashneq'].fillna(0))
    ev = ev.where(ev > 0)                       # enterprise value
    return {
        ...
        'fcf_ev':   P['fcf'] / ev,              # free-cash-flow carry
        'buyback':  -P['ncfcommon'] / A,        # net buyback yield
        ...
    }

Each factor becomes a cross-sectional percentile rank, and the basket-selection code from the momentum article — long the top ranks, short the bottom, with the same rank hysteresis to damp turnover — turns those ranks into a long-cheap / short-rich book. Same machinery, different signal.

How Big Is the Carry Spread?

Before returns, the raw premium. Using the same point-in-time panels and production-spec universe (median about 2,660 liquid US names), we measured the average yield of the top and bottom deciles each month:

Read the FCF/EV row concretely. The cheapest decile of the market threw off, on average, a free-cash-flow yield of nearly 12% on enterprise value; the most expensive decile had a negative 11% yield — these are cash-burning companies. Holding the cheap book and shorting the rich one collects a 23-point gap in cash-flow yield. That is the equity carry, and it is not subtle. The buyback spread is wider still, but note that the bottom decile there is dominated by heavy issuers — serial diluters — whose −32% figure is stretched by a handful of extreme cases; the FCF/EV spread is the cleaner headline.

A large yield spread only matters if it actually predicts returns, so we ran both factors through the same information-coefficient harness used in the factor-mining article — the monthly rank correlation between the signal and next month’s returns. FCF/EV scored a mean IC of 3.69% with a t-statistic of 4.41 (positive in 63% of months); buyback yield scored 3.17% (t = 3.64). Both clear the bar for statistical significance comfortably, and both sit exactly where intuition says they should: stronger than the momentum signal from the previous article (t near 1.4), weaker than the very best cash-flow-quality factors (t near 6). Carry is a solid, mid-tier source of edge — not the strongest lever in the composite, but among the most economically intuitive.

What the Carry Sleeve Returned — and When It Didn’t

We then ran the flagship FCF/EV factor through the real basket code as a 30×30 long/short sleeve, month-end to month-end, equal weight, over 122 months (April 2016 to May 2026). As with the momentum article, this is a scoped, gross-of-costs research calculation that isolates the signal — not the full engine with its open fills, slippage, and stops.

The honest headline: over this particular decade, the long-short carry sleeve returned +300% gross — respectable, but it roughly matched the S&P 500 and badly trailed the Nasdaq-100. A decade led by expensive megacap technology is close to the worst-case environment for a strategy whose whole premise is being short expensive stocks. That is not a bug in the factor; it is the risk premium showing you its teeth. And the year-by-year path is where the “paid to wait” character really lives:

Look at 2019–2020 next to 2021. Two years of the carry trade earning almost nothing while growth ran — the kind of stretch that makes investors capitulate on value entirely — followed by a single year, 2021, that returned +77% as the spread violently re-rated. Then 2025 gave back 28%. This is the FX-carry payoff shape transplanted into equities: long stretches of modest positive carry, punctuated by sharp reversals in both directions. You cannot collect the premium without sitting through the droughts, and the droughts are precisely when it feels most rational to quit.

The Risk: Droughts, Value Traps, and the Cost of the Short

The drought is the premium. The 2019, 2020, and 2025 rows above are not the strategy failing — they are the strategy doing its job of bearing a risk that others do not want. A value investor who cannot tolerate multi-year underperformance relative to a growth benchmark will always sell at the bottom of the drought, which is another way of saying they will systematically hand the premium to whoever can hold. This is the single hardest thing about the trade and it is behavioral, not analytical.

Cheap can mean broken — the value trap. The deepest hazard in carry is that a stock is cheap for a reason: its cash flows are about to collapse, and the yield you are “paid” is a mirage. We tested this directly. Taking the cheapest third of the market by FCF/EV each month and splitting it by quality (gross profitability, above vs below median), we compounded the two halves separately:

Same starting point — all cheap on cash-flow yield — but the high-quality half returned more than two and a half times what the low-quality half did. The cheap-and-unprofitable names are the value traps: statistically cheap, economically deteriorating. This is the concrete reason our engine never trades value in isolation. It pairs the carry factors with the quality factors from the fundamental-mining article — cash profitability, interest coverage, gross profitability — so that “cheap” is always filtered through “and actually earning its keep.” How those factors combine into a single composite is its own article later in this series.

There is a natural bridge here to single-name work: the same cash-flow-yield lens that ranks three thousand names is what a careful analyst applies to one, and our individual value theses lean on exactly these inputs — free cash flow, buybacks, enterprise value — done by hand. The systematic version simply refuses to be talked out of the discipline by a good story. The rest of the curriculum, including how carry combines with momentum and quality, is on the Macro & Strategy hub.

The AlphaEdge Take

Equity carry is the honest translation of the FX carry trade: stop borrowing yen to buy the Aussie dollar and start getting paid, in free cash flow and buybacks, to hold cheap productive businesses funded by shorting expensive empty ones. The premium is real and large — a 23-point cash-flow-yield spread between the cheapest and dearest deciles — but it is a risk premium, not a free lunch: it matched the S&P and trailed the Nasdaq across a growth-led decade, earned almost nothing in 2019–2020 before snapping back +77% in 2021, and gave back 28% in 2025. Two rules make it survivable — never hold cheap without checking it is also profitable (the cheap-high-quality book beat the cheap-low-quality traps by 2.6 to 1), and size it so you can still be holding through the drought that always comes, because the drought is exactly what you are being paid for.

Georgi Kuzmanov

Senior Equity Analyst & Founder at AlphaEdge. Columbia University MSFE (2011–2013). Covering equities, macro, and geopolitics for serious investors.