In times of crisis, investors turn to strategies where the upside is many times greater than the downside. A barbell strategy enables investors to protect the downside risk of their investment portfolios while maximizing the upside potential.
A barbel portfolio diversification strategy is based on the concept of balancing out reward and risk with high-risk and low-risk assets while avoiding investing in medium-risk assets. In other words, the strategy fits in with an image of a barbell: one side of the bar is furnished with safer and more stable assets that account for 40% of the portfolio, and the other side, making 40% of the portfolio allocation, is fitted with riskier and more speculative assets. The other 20% is distributed between 10% of very risky assets on the one side, and 10% of very safe and stable ones. The attached image depicts this concept.
For example, initial public offerings (IPOs) or small start-up companies are attributed to high risk, speculative stocks’ categories, whereas blue-chip stocks of S&P 500 are less risky but still vulnerable to volatile markets. Bonds, bank certificates of deposit (CDs), cash are safer and Treasury bonds are considered the safest of all.
With a barbell, a portfolio manager can rebalance investors’ portfolios as the yield curve straightens by tilting toward higher-quality, interest-rate-sensitive securities at the expense of the riskiest sectors of the credit market. 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 configure the portfolio toward higher-risk assets at more attractive prices.
For example, the barbel strategy can include balancing out investing in structural growth in US equities with lucrative cyclical exposure in some European and Japanese stocks, or holding a well-diversified portfolio of equity and bond exposures across countries and sectors that can help make the most return on varying rates of growth that are in line with an individual investor’s risk/return appetite.
Sacrificing liquidity should earn a return premium or at least it should be included be the objective. As a rule, the liquidity offered by fund managers should be aligned with the liquidity needs of the strategy. This may be a 30, 45, 60, or more days withdrawal period, although some lockups may have to be accepted for the initial period. A less-liquid barbell strategy-based portfolio, built for greater uncertainty, should include investing in more market-neutral combinations of securities.
The barbell portfolio strategy has sown some resilience during past periods of heightened volatility. According to Bloomberg data, from June 2008 to December 2011, the S&P500 registered monthly losses of 0.1%, whereas some barbell portfolios of US stocks saw monthly gains of 0.5% on average. On a cumulative basis, this translated to a 10.2% loss for the S&P 500 and a 14.3% gain for the “barbell portfolio”.
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