Barbell

The barbell is an investment strategy applicable primarily to a fixed-income portfolio, in which half the portfolio is made up of long-term bonds and the other half short-term bonds. The “barbell” gets its name because the investment strategy looks like a barbell with bonds heavily weighted at both ends or the short-term and long-term maturities.

The barbell strategy will have a portfolio consisting of short-term bonds and long-term bonds, with no intermediate bonds. Short-term bonds are considered bonds with maturities of five years or less while long-term bonds have maturities of ten years or more.

Long-term bonds tend to pay higher yields or interest rates than short-term bonds since investors demand a higher yield for holding bonds for a longer period. However, fixed-rate bonds carry interest rate risk, which occurs when interest rates are rising, and investors are holding fixed-rate bonds at lower interest rates. As a result, a bondholder might earn a lower yield compared to the market in a rising-rate environment. Long-term bonds carry higher interest rate risk than short-term bonds since investors can reinvest short-term bonds as they mature taking advantage of a rising-rate environment.

The barbell strategy attempts to get the best of both worlds by allowing investors to invest in short-term bonds taking advantage of current rates while also holding long-term bonds that pay high yields. If interest rates are rising, the bond investor will have less interest rate risk since the short-term bonds will be rolled over or reinvested into new short-term bonds at the higher rates.

For example, if an investor is holding a 2-year bond that pays a 1% yield, and interest rates rise so that current 2-year bonds now yield 3%, the investor let's the existing 2-year bond mature and buys a new 2-year bond paying the 3% yield. Any long-term bonds remain untouched until maturity.

As a result, the barbell investment strategy is an active form of portfolio management, as it requires frequent monitoring since the short-term bonds must be continuously rolled over into other short-term instruments as they mature.

Barbell strategy offers diversification and reduces risk while retaining the potential to obtain higher returns. If rates rise, the investor will have the opportunity to reinvest the proceeds of the shorter-term bonds at the higher rates. The short-term securities also provide liquidity for the investor and flexibility to deal with emergencies since they mature frequently.

• The barbell is an investment strategy applicable primarily to a fixed-income portfolio, in which half the portfolio is made up of long-term bonds and the other half short-term bonds.
• The barbell strategy allows investors to take advantage of current rates by investing in short-term bonds while also getting the benefit of higher yields by holding long-term bonds.
• The barbell strategy can also mix stocks and bonds whereby half the portfolio is anchored in bonds and the other half in stocks.

The barbell strategy still has some interest rate risk even though the investor is holding long-term bonds with higher yields than the shorter maturities. If those long-term bonds were purchased when yields were low, and rates rise afterward, the investor is stuck with 10-30-year bonds at yields much lower than the market. The investor must hope that the bond yields will be comparable to the market over the long-term.

Since the barbell strategy does not invest in medium-term bonds with intermediate maturities of 5-10 years, investors might miss out if rates are higher for those maturities. For example, investors would be holding 2-year and 10-year bonds while the 5-year or 7-year bonds might be paying higher yields.

All bonds have inflation risk. Inflation is a measure of the rate at which the average price level of a basket of selected goods and services in an economy increases over a period of time. The interest rate paid on a bond is usually a fixed rate. However, fixed-rate bonds might not keep up with inflation. If prices rise by 3% and the bond pays 2%, investors have a net loss in real terms.

The traditional notion of the barbell strategy calls for investors to hold very safe fixed-income investments. However, the allocation can be mixed between risky and low-risk assets. Also, the weightings for the bonds or assets on either side of the barbell don't have to be fixed at 50% but can be adjusted to market conditions as required.

The barbell strategy can be structured using stock portfolios with half the portfolio anchored in bonds and the other half in stocks. The strategy could also be structured to include less risky stocks such as large, stable companies while the other half of the barbell might be in riskier stocks such as emerging market equities.

As an example, let's say an asset allocation barbell consists of 50% safe, conservative investments such as Treasury bonds on one end, and 50% stocks on the other end.

Let's say that market sentiment has become increasingly positive in the short-term and it's likely the market is at the beginning of a broad rally. The investments at the aggressive end (equities) of the barbell perform well. As the rally proceeds and market risk rises, the investor can book gains and trim exposure to the high-risk or equity side of the barbell. The investor sells a portion, or 10% of the equity portfolio and allocates the proceeds to the low-risk fixed-income securities. The adjusted allocation is now 40% (stocks) to 60% (bonds).