In the physical world, a barbell is a bar with two equal weights on either side that offset one another, creating a perfect balance. Apply this same concept to the investing world, and you have a very simple strategy (by the same name) used by some of the most sophisticated managers and investors. Some of the potential benefits of this strategy are hedging, risk reduction and smoothed returns.
Physical barbells are perfectly balanced. In the investing world, nothing is perfect, but taking two asset classes that tend not to correlate well and allocating between the two can offer some of the aforementioned benefits. When barbells work, one asset zigs while the other zags.
The most common barbell is between stocks and bonds. It is common to see a talking head in financial media drone on about the benefits of the 60/40 or 50/50 portfolio. But it is less common to hear about the benefits of barbelling within the same asset class – pitting stock against stock or bond against bond in order to achieve diversification.
How to Barbell Using Bonds
For the bond investor, there are two common ways to barbell: through duration and quality.
Duration: The duration barbell consists of offsetting shorter dated bonds with those maturing later. This has historically reduced interest rate risk, as longer dated bonds, while usually yielding more, carry more risk in a rising rate environment but generally provide the benefit of higher yield in a benign interest rate environment. *
Make no mistake, rising rates will hurt almost any bond portfolio, but the shorter-dated sleeve will likely hold up much better since they will begin to mature sooner, giving an investor the ability to reinvest at juicier yields.
So, for example, to barbell using duration, an investor might buy a corporate bond ETF with a duration of four years, then buy an equal amount of an ETF in the same category, but with a duration of 13 years.
Quality: Another fixed income barbell is achieved through the quality of the bond. On this spectrum, U.S. Treasuries are the highest quality, and high-yield corporates (junk) are the lowest. Junk bonds are riskier because the issuer’s ability to repay them is questionable. Thus, they are forced to pay a premium interest rate to entice an investor to take the risk (currently yielding 5% to 6%*). Treasuries are guaranteed by the U.S. Treasury and therefore sport a lower yield – just north of 3%* for a 30-year Treasury as of this writing.**
In a credit crisis, junk bonds can be a scary ride, but bonds guaranteed by the U.S. Treasury might act as a stabilizing force in this barbell. But remember, you don’t have to go to the extremes in a barbell. A more moderate example would be to balance moderately safe AA rated bonds on one end and moderately risky BBB on the other.
* Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Bond yields are subject to change. Certain call or special redemption features may exist which could impact yield.
** High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. Yield figures are per S&P High Yield Corporate Bond Index and S&P U.S. Treasury Bond 30-Year Index.
How to Barbell Using Stocks
There are countless ways to barbell within stocks. There is large cap vs. small cap, tech vs. staples, domestic vs. International and many more, but probably the most common is growth versus value. These two classes tend to have their day in the sun, then give way to the other.
In the recent past, growth dominated for years but recently gave way to its value brethren. Will this persist? Will it reverse? With a barbell, you shouldn’t necessarily care, because the key to this strategy is in the next step: rebalancing.
A weightlifter does not want a barbell with uneven weights because it feels awkward and might even cause injury. Similarly, with investing barbells, one should strive to maintain the original balance. An epic run for growth in recent years made a lot of barbells growth-heavy.* But, in the first half of 2022, the Russell 1000 Value Index outperformed the Russell 1000 Growth Index by almost 16% **
There is no universal rule regarding the “when” of rebalancing. Some mutual funds and ETFs rebalance quarterly regardless of how lopsided the barbell is. For the lay-investor the non-scientific answer might be “when things are out of whack.”
Rebalancing when a barbell moves a percentage point might be a waste of time, but when a portfolio that was originally 50/50 becomes 60/40, such as the previous growth/value example – well that might indicate that the dominance of growth is getting a little long in the tooth and it might be time to rebalance. Currently growth stocks are grossly out of favor, but history tells us that they are lurking in the shadows, waiting for their next run of dominance.
If you are already using the growth/value barbell, keep an eye out for an opportunity to rebalance out of value and into growth.
* Growth investments may be more volatile than other investments because they are more sensitive to investor perceptions of the issuing company’s growth of earnings potential. Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.
** From 1/1/2022- 6/17/2022 the Russell 1000 Value Index outperformed the Russell 1000 Growth index by 15.7%
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All investing involves risk, including loss of principal. No strategy assures success or protects against loss. ETFs trade like stocks, are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF's net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors. ETFs concentrating in specific industries are subject to higher risks and volatility than those that invest more broadly.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Asset allocation and diversification do not protect against market risk, nor ensure a profit or protect against a loss.
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. Securities and advisory services offered through LPL Financial, a registered investment adviser. Member FINRA/SIPC.
Brian Murphy is a Market Strategist and Investment Manager at Frazier Investment Management (opens in new tab)in Southern Rhode Island. Before joining the Frazier team, he served in the U.S. Navy for 11 years as a carrier jet pilot. Brian has experience managing several different strategies and products, including equity, fixed income, long/short portfolios and options. He believes that managing risk is the key to successful outcomes and works with clients nationwide to achieve their investing goals.
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