An introduction to the Barbell Strategy
If you’ve only got a minute:
- Remember to select an investment strategy that takes into consideration your investment goals, risk appetite and time horizon
- A barbell strategy is an investment portfolio strategy with exposures at two ends of the risk spectrum with little in between.
- Historically, adopting such a strategy has allowed investors to gain better-than-average returns in periods of market volatility.
Before embarking on your investment journey, one of the key questions to ask yourself is what kind of investment strategy to adopt. This can be a lengthy process as there is a variety of approaches to choose from, each with its own pros and cons.
Key considerations to guide you when choosing an investment strategy include taking measures to understanding your:
- Investment goals/objectives
- Risk appetite
- Time Horizon
An investment strategy is what guides an investor's decisions based on goals, risk tolerance, and future needs for capital. In other words, it results in choosing the proportion of each financial instrument (e.g. stocks, bonds and alternatives) that make up your portfolio according to the three key considerations for investing.
Strategies include those that seek strong, rapid growth, where investors are more concerned with capital appreciation of stock prices. On the other hand, investors can choose to focus on generating dividend income and preserving wealth. This latter strategy is often considered lower risk than the former.
Investors can also look at adopting both of these styles. One such strategy that combines both these methodologies is the Barbell and this is an investment strategy advocated by DBS Chief Investment Office (CIO) since August 2019.
What is the Barbell Strategy?
In adopting a Barbell Strategy to portfolio construction, investors achieve a balance between risk and reward by investing in assets at both ends of the risk spectrum. They often avoid holding assets that would make up the middle of the spectrum.
Barbell strategy-influenced investment portfolios can be made up of only stocks, only bonds or a combination of both asset classes along with alternative investments like Gold.
The barbell approach is a flexible one. Investors can tailor the strategy to suit their respective investment goals, risk appetite and time horizon.
When constructing an investment portfolio, a younger investor – usually able to stomach more risk – might focus on having more exposure to high growth stocks for capital appreciation and dividend stocks for a mix of capital appreciation and recurring income.
Meanwhile, exposure to bonds might take a backseat, taking up less than a quarter of the portfolio.
In contrast, an investor who is nearing retirement might be more interested in preserving wealth and building up a base of stable, recurring income. In this case, more weight will be placed on bonds and to a lesser extent, dividend yielding equities like real estate investment trusts (Reits) or blue-chips.
Their objectives may be different, but it is important to remember that both are pursuing strategies that give could give them each an optimal return.
How does it compare to a balanced portfolio?
The examples of how a barbell strategy can be employed by investors with different profiles might draw some similarities with a balanced portfolio. As such, you might ask: “How is a barbell strategy different from a balanced portfolio?"
In general, balanced portfolios buy a diverse range of stocks, bonds, real estate and alternatives like gold for safety. The idea behind this is to create stability by having assets with different risk/reward profiles.
Even if growth prospects are average, the asset allocation within the portfolio might not change substantially. Moreover, as no conviction exposures are taken, there is a chance that investors might get bland (though stable) market returns.
By employing a Barbell Strategy, investors can take advantage of capturing strong gains in sectors that are expected to outperform the market while balancing that risk out with dividend yielding stocks or high yield bonds.
DBS believes a barbell portfolio strategy helps investors build a resilient investment portfolio in challenging times like the economic slowdown brought about by the Covid-19 outbreak.
Globally, central banks and governments have turned to unprecedented stimulus measures to keep the global economy afloat. The result of this has seen interest rates fall, and the expectation is that they will remain low in the coming years. Moreover, these stimulus measures have supported financial markets but they remain volatile.
The pandemic has also seen many businesses ramp up their digitalisation efforts while those who fail to keep up with this change, face unprecedented disruption.
If you recall, by adopting a barbell strategy, investments are heavily weighted at both ends of the risk spectrum. This means being overweight on high-growth stocks on one end of the portfolio, while having stable, income-generating investments on the other end.
An example is illustrated below:
The “Growth” half of the strategy consists of exposure to high conviction secular growth trends. Companies that fit into these themes, benefit from the world transforming into a digital economy that address the needs of an aging population, capture the rise of China's middle class, and the rise of millennial spending. Such firms are primed to benefit from strong performance in the long-term.
That said, high growth areas often come with risks and will inevitably face volatile price movements. This why a balance is created with income generating assets. The “Income” component consists of exposure to dividend equities, Reits and corporate bonds, which provides investors with steady income stream for downside protection.
By doing so, investors can capitalise on long-term, irreversible growth trends while mitigating short-term volatility through income-generating assets; the barbell strategy entails minimizing exposure to sectors challenged by disruption. The portfolio’s two-pronged strategy has become especially relevant today as uncertainties persist.
Performance in periods of volatility
The Barbell Strategy has shown itself to be resilient in past periods of heightened volatility.
During the Great Financial Crisis, stock portfolios bled during the September 2008 to February 2009 period. US Equity benchmarks plummeted 43% but a barbell portfolio of US stocks fell just 14%.
But the barbell strategy doesn't just provide downside protection during trying times but also better-than-average gains.
Taking the period of June 2008 to December 2011, the S&P500 registered monthly losses of 0.1% a barbell portfolio 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”.
Since instituting the barbell for its private banking clients in August 2019, DBS has seen the strategy return 22.4% net of fees, outperforming the composite benchmark’s 15.9% total return by 650 bps.
In the first 11 months of 2020, the strategy maintained a positive performance of 14.3% net of fees, ahead of the composite benchmark’s total return of 9.4%. Since inception, the strategy has returned 22.4% net of fees, outperforming the composite benchmark’s* 15.9% total return.
*50/50 - Global equities / Bloomberg Barclays US Agg Bond Index
Putting the strategy into play for the retail investor
Building an investment portfolio through stock picking can be an arduous task as it often takes up a fair amount of time to research all potential companies.
That said, one of the common ways for retail investors to simplify this process and implement such an investment strategy is by using a combination of individual stocks and Exchange-traded Funds (ETFs).
ETFs are marketable securities that can be traded like shares on a stock exchange. ETFs attempt to track the price of an index, commodity, bonds, or basket of assets.
Using ETFs to build up your investment portfolio allows you to get diversified exposure to stocks in a particular country or sector, usually for less cost than buying individual stocks.
For example, for the growth half of the portfolio, you could pick a tech-focused ETF for broad exposure to the sector and then add 2-3 individual tech stocks that you have a strong understanding of. Meanwhile, gaining exposure to Chinese equities can be easily achieved through the purchase of an ETF that tracks the top Chinese stocks by market capitalisation.
For the income half of the portfolio, exposure to Reits can easily be achieved by purchasing a Reit ETF along with a couple of individual Singapore-listed Reits. The same applies for dividend equities.
While this is a simplistic example of diversification, it can serve as a starting point to build up one’s investment portfolio.
If your current investment portfolio needs to be adjusted a fair bit to adopt the barbell strategy, fret not, as investment strategies are often flexible. This means that you can make changes when the current strategy does not suit your risk tolerance or schedule. That said, do expect to incur costs of adjusting the balance of your portfolio.
One way to spread to out such costs is not to rush into portfolio adjustment. Instead pick opportune times to sell your existing assets for new ones.
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Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.
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