In finance, a barbell strategy is formed when a
trader invests in long- and short-duration
bonds, but does not invest in intermediate-duration bonds. This strategy is useful when
interest rate
An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, th ...
s are rising; as the short term maturities are rolled over they receive a higher interest rate, raising the value. A contrasting strategy is the
bullet strategy In finance, a bullet strategy is followed by a trader investing in intermediate-duration bonds, but not in long- and short-duration bonds.
The bullet strategy is based on the acquisition of a number of different types of securities over an exten ...
, which involves investing only in intermediate-term bonds.
Concept
A barbell strategy is one of several different types of portfolio strategies that is designed to create a reasonable
return on the investments that are part of the asset
portfolio
Portfolio may refer to:
Objects
* Portfolio (briefcase), a type of briefcase
Collections
* Portfolio (finance), a collection of assets held by an institution or a private individual
* Artist's portfolio, a sample of an artist's work or a ...
. The barbell strategy is built around the concept of focusing on the maturities of the securities in the portfolio by making sure the maturity dates are either very close or at a distant date. It is similar to the
laddered approach.
Application
The key to employing a barbell strategy is seeking to include bonds and other securities set to mature either in the short term or the long term. While it is always a good idea to include a mix of investments with a variety of maturation dates, this approach concentrates those dates at opposite ends of the spectrum. This means that two blocks or groups are created within the portfolio, rather than having securities that mature consistently from one period to the next.
Benefits
The barbell strategy allows for a quick turnover of a significant amount of the assets in the portfolio at one time. For example, attention should be paid to the block of short-term investments, so they can all be rolled over into new short-term investments as they reach maturity. Typically, this leads to an increase in the value of the investments that are turned over, thus increasing the overall value of the investment portfolio.
Theoretical results
Under simplistic assumptions about forward rates, a bar-bell portfolio comprising only the shortest dated bond and the longest on offer has been shown to maximize modified excess return.
Variations
One variation of the barbell strategy involves investing 90% of one's assets in extremely safe instruments, such as treasury bills, with the remaining 10% being used to make diversified, speculative bets that have massive payoff potential. In other words, the strategy caps the maximum loss at 10%, while still providing exposure to huge upside.
This strategy works best during periods of high inflation for three reasons: High interest rates make
put option
In finance, a put or put option is a derivative instrument in financial markets that gives the holder (i.e. the purchaser of the put option) the right to sell an asset (the ''underlying''), at a specified price (the ''strike''), by (or at) a s ...
s cheaper in accordance to the
Black Scholes option pricing formula,
stock crash
A stock market crash is a sudden dramatic decline of stock prices across a major cross-section of a stock market, resulting in a significant loss of paper wealth. Crashes are driven by panic selling and underlying economic factors. They often foll ...
es have historically occurred during periods of high interest rates (
1987
File:1987 Events Collage.png, From top left, clockwise: The MS Herald of Free Enterprise capsizes after leaving the Port of Zeebrugge in Belgium, killing 193; Northwest Airlines Flight 255 crashes after takeoff from Detroit Metropolitan Airport, k ...
, 1998,
2000
File:2000 Events Collage.png, From left, clockwise: Protests against Bush v. Gore after the 2000 United States presidential election; Heads of state meet for the Millennium Summit; The International Space Station in its infant form as seen from ...
,
2007
File:2007 Events Collage.png, From top left, clockwise: Steve Jobs unveils Apple's first iPhone; TAM Airlines Flight 3054 overruns a runway and crashes into a gas station, killing almost 200 people; Former Pakistani Prime Minister of Pakistan, Pr ...
, etc.), and a high interest rate helps finance the trader's bankroll for when the market doesn't crash, which is most of the time. With interest rates still at zero, this strategy is much less effective. Thirty-year bonds pay more, but are volatile. Foreign and corporate bonds are also quite volatile and far from risk-free.
References
External links
*
What is Barbell Strategy? In Hindi{{DEFAULTSORT:Barbell Strategy
Bond market