Credit barbell strategies are designed to provide protection on the downside, participation on the upside, and efficient income. But with government bond yields at historic lows, can these fixed-income strategies still meet their objectives? We think so.

Credit barbells combine interest-rate-sensitive assets with credit assets in a single portfolio. This approach can help managers get a handle on the interplay between interest-rate risk and credit risk and make better decisions about which way to lean as conditions change.

Credit barbell strategies are effective because they blend asset classes whose returns are negatively correlated. Risk-mitigating assets, such as US Treasuries, tend to do well when growth slows, while return-seeking assets, such as high-yield corporates, shine when growth accelerates and interest rates rise.

In this way, strong returns on one side of the barbell can help offset weakness on the other. This was the case when the capital markets sold off sharply in March. While returns for some income-generating assets—such as emerging-market debt and securitized assets—were down by more than 20%, the Bloomberg Barclays US Intermediate Treasury Index enjoyed a flight to safety that boosted monthly returns above 5%. In credit barbells, Treasury positions helped mitigate the broader market drawdown.

Negative Correlation Still Key to Downside Protection

But what of fears that the relationship between risk-mitigating and return-seeking assets has broken down under the extreme stress of the pandemic? That would be concerning. If the correlation between Treasuries and high yield has turned positive, that could limit the downside-protection benefits of a barbell.

To address this concern, we’ve given recent correlations a closer look. In Display 1, we divided correlation data between the 10-year US Treasury yield and high-yield spreads into days when spreads narrowed (a risk-on environment) and days when spreads widened (a risk-off environment) over rolling six-month periods.