Why barbell strategy

This is mainly because the return streams tend to be negatively correlated; one does well when the other struggles, and a manager can alter the weightings as valuations and conditions change. A barbell approach can work at any time in a market cycle, but we think conditions today are especially ideal for it—in particular for investors who want to limit their downside risk without giving up too much income.

Here are three reasons to lift a barbell today:. Most credit assets are expensive today. Take the US high-yield market. The average yield spread—the extra yield over comparable government bonds—has hovered recently around 3. This should be a concern for investors who reduced duration—a measure of interest-rate sensitivity—when interest rates were rising and over-allocated to credit.

That was a common strategy in as the US Federal Reserve delivered four interest-rate increases and economic growth was strong. Investors learned that at the end of last year, when markets began to fear the Fed had tightened policy too much and credit and other risk assets sold off.

We now know the fourth-quarter downturn was a correction, not the start of a prolonged risk-off environment. The drawback of a barbell strategy is that the investor misses the opportunity to use intermediate-term bonds in their portfolio, betting that returns over time will be higher without these mid-range bonds.

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Learn about our editorial policies. Reviewed by JeFreda R. JeFreda R. At some point, the expansionary period will end and the downturn phase will begin.

With trade volume collapsing, we expect to be the worst year in a decade for the world economy. That likely would mean more Fed rate cuts to come and, if necessary, even more aggressive easing. All of this tells us two things. The possibility of slower growth ahead means interest-rate exposure should help to cushion your portfolio against volatility and drawdown risk.

US yield curves are flat. Why does this matter? This makes a portfolio more liquid. Should credit markets sell off, investors can sell their outperforming US Treasuries and other highly liquid quality assets and rebalance toward higher-risk assets at more attractive prices.

When it comes to the credit side of the barbell, flat curves make higher-quality, intermediate maturity bonds more attractive than longer ones because they deliver more yield per unit of duration, with the sweet spot somewhere between three and five years. You can reduce volatility without giving up too much return.

We call this a risk-weighted barbell because credit is typically twice as volatile as interest-rate-sensitive assets, so investors would have to hold more rate exposure to even out the risk weighting on each side.