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The Best Of Both Worlds

October 2016

Under barbell investment strategy, a portfolio aims to take advantage of both short-term and long-term assets to maximize risk-adjusted returns

Negative interest rates, impending rate hikes, helicopter money, quantitative easing, inflation or deflation; one thing the last few years have evinced is underlining the fact that today’s financial world realities challenge the traditionally understood investment strategies. The same constantly presses investment managers to theorize and practise newer strategies – Barbell Investing being one of them.

Traditionally conceived as a fixed-income strategy, Barbell investing involves investing in which the maturities and/ or durations of included securities are concentrated at two extremes. As a case in point, a portfolio may be designed to allocate 50% of its fixed-income securities at the short end of the yield curve while the remaining 50% is held in fixed-income securities at the long end with nothing in the middle. Thus resembling the Barbell. In effect, your portfolio holds of mix of ‘defensive’ holdings in the short bucket providing more flexibility and ‘offensive’ holdings in the long bucket offering higher interest yields. Short-term bonds give an investor the liquidity to adjust potential investments every few months or years. If interest rates start to rise, the shorter maturities allow an investor to reinvest principal in bonds that will realize higher returns than if that money was tied up in a long-term bond. The long-term bonds give an investor a steady flow of higher-yield income over the term of the bond.

mastering-the-markets-chartoctnovAdvocates of the theory include Nassim Taleb who put forth a variant of the same in the book ‘The Black Swan’ suggesting this strategy as offering amongst the least risky portfolio approach. He advocates putting 85% – 90% in ultra-safe cash and the remaining in a large number of highly speculative bets, forming the two ends of the barbell and in effect insulating the portfolio from Black Swan events.

However, while devising such a strategy, the correlation between the investment types at either end of the barbell needs to be accounted for. As has been pointed out by experts, for a barbell strategy to succeed over the long term, the two sides of the barbell need to maintain low correlation to each other. When two sides are highly correlated, it ceases to be an effective way of managing risk and becomes instead a highly risky strategy. As per Credit Suisse Cross-Market Contagion indicator, which tracks price relationships in equities, credit, currencies and commodities, different markets are influencing each other in 2016 at a higher rate that any time since the measure was invented in 2008. While the gauge has slipped from the level of 75% post Brexit, it still averages 65% this year, climbing for a second year after bottoming at 57% in 2014. The elevated level of cross-asset correlations highlights the danger of simultaneous selloffs thus increasing the caution in implementing the Barbell Strategy.

Did You know??

Barbell investing involves investing in which the maturities and/ or durations of included securities are concentrated at two extremes.

In effect, your portfolio holds of mix of ‘defensive’ and ‘offensive’ holdings

Advocates of the theory include Nassim Taleb who put forth a variant of the same in the book ‘The Black Swan’.

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