Building the Perfect Barbell

Investors who want to reduce risk and maintain a steady income might consider a barbell strategy that pairs interest rate–sensitive bonds with high-yielding credit assets. But first, it’s important to strike the right balance.

Combining the two types of asset in a single strategy known as a credit barbell makes sense because the returns of each are usually negatively correlated. When riskier, growth-oriented credit assets such as high-yield bonds fall in value, government bonds and other interest rate–sensitive assets usually rise. A portfolio that includes both has the potential to weather most markets, as investors can rebalance by selling the outperformers on one side and buying the underperforming bonds on the other.

But what’s the right way to build a barbell? Would maintaining a simple 50/50 split between interest rate–sensitive and credit assets do the trick?

The answer will depend on each investor’s needs and comfort level. Let’s look at three potential barbell strategies that an investor might choose. For these hypothetical portfolios, we use US Treasuries to represent interest-rate risk and US high yield as a proxy for credit risk.

In practice, investors would want to diversify their portfolios with exposure to a wide variety of fixed-income sectors, including government bonds, bank loans, corporate and hard-currency emerging-market debt, inflation-linked bonds, and securitized assets.


A simple 50/50 split between Treasuries and high yield might appeal to investors with high income requirements and a high risk tolerance. This is because credit assets are at least twice as volatile as high-quality government debt. So when it comes to risk exposure, an even market-weighted split between the two—we’ll call it the naive barbell approach—is actually tilted toward credit.

To reduce some credit risk, an investor might cut out low-quality, CCC-rated “junk” bonds, the riskiest slice of the high-yield universe. These securities are at the highest risk of default, and steering clear might make sense during the late stages of a credit cycle. This risk-managed barbell would give up a small amount of return in exchange for lower risk.

Investors who want to take the same amount of risk on each side of their income portfolio, however, would need to build a risk-weighted barbell. Because credit is at least two times riskier than rates, investors would have to hold more rate exposure to even out the risk weightings—roughly 65% in Treasuries and 35% in high yield.

The annualized returns and risks of each approach vary. But compared to Treasuries and high yield alone, all three of these hypothetical portfolios had better returns per unit of risk over the last two decades (Display).

It’s important, however, to actively manage the weights. Setting a static allocation and forgetting it won’t produce solid long-term returns. If the assets on one side of the barbell look expensive, a manager should be able to change the balance and lean toward lower-priced opportunities on the other side. If asset prices on both sides seem high, she may need to reduce overall portfolio risk.