The Barbell Investment Strategy is basically a tale of two extremes in order to increase risk adjusted returns on your investment portfolio. Quite simply it involves investing most (90% for example) in cash and t-bills. Ultrasafe investments that pay a little interest, but are not likely to ever lose their value. The remaining portion you invest in risky assets. It also considered by some one of the more risky investment strategies for bond investors.
But others (notably philosopher / investor Nassim Taleb) believe that it is the LEAST risky portfolio approach. The reason being that it is a black swan investment strategy that helps insulate you from black swan events, because he argues that no one can predict the future (I agree) and In his book The Black Swan, he advocates the Barbell strategy, putting 85% to 90% of your investments in ultra-safe cash and the remaining in a large number of highly speculative bets (eg venture capital style investments). That way your investment portfolio will not be floored by Black Swan events (the maximum you can lose is the 10% to 15% invested in the diversified, speculative investments).
The Barbell Bond Portfolio
Originally a bond portfolio approach, the barbell strategy invests in very short term securities and a range of longer term securities. This makes the portfolios duration somewhere in the middle. The short end securities are turned over quickly, rolling them into new short term securities. Usually this leads to a higher increase in value. The purpose of this is that mid-range securities can often be mispriced for the risks involved; they have longish maturities yet often their coupon is not a lot above T-bills.
The risk in this approach is that the value of bonds at the longer end are more volatile, giving greater variability of returns in the short run. For example, if the yield curve steepens at the long end and falls at the short end, you will lose out in both directions, making a (massive) loss as long term yields rise, while receiving a small amount of interest at the short end.
Variations on the Barbell Investment Strategy
Private Equity
Another variation on a theme is to use Bar Bells in a Private Equity portfolio. This means that you have substantial liquid investments and a selection of illiquid private equity plays, either directly or through a fund.
What’s Private Equity? – A class of equity investments that are not traded on a stock exchange. Typically a PE house will privatise a listed company or purchase any number of already private companies and exit the investment after a couple of years, either by onselling them (trade sale) or IPO.
This is the approach proposed by Taleb and used by a number of leading Private Equity managers.
A Whole Stock Portfolio
This version is a corruption of the first two, in that it has no cash investments. Rather it has a portfolio is liquid large cap stocks, with a number of smaller speculative stocks (eg tech companies or blue sky mining). The downside to this approach is that the entire portfolio is subject to equity risk (such as occurred in 2007-2009 and 2001 and 1987 and….). This would lead to a situation in abnormal market conditions where the portfolio takes large losses as all equity investments fall.
A short cut approach
One way of simulating a barbell approach is through the use of index funds. For example an investor could use a T-bill fund along with the iShares Barclays 20+ Year Treasury Bonds to simulate the barbell strategy.
Final Word
The Barbell investment strategy is designed to allow an investor to achieve maximum returns without taking on unnecessary (and unmeasurable) risk. While still in its infancy, it is a sophisticated strategy that could be considered by all High Net Worth Individuals.
What are your thoughts on the barbell investment strategy?
Perfect for the conservative investor with a slight thrill for gambling!
I guess if you have a huge net worth and conserving capital is your #1 objective, this might be a good plan. I doubt this will work out well in the long run. The high risk high reward part of the portfolio won’t always have large gain, a large percentage of it could disappeared.
The merits of this strategy are hard to explain in one post; however, if this is something you are interested in, Taleb describes fragility and anti-fragility (the barbell approach) quite eloquently in a chapter excerpt from his upcoming book about the application of such principles to finance and the world around us. Let me know what you think about it if you check it out!
From Antifragile: Things That Gain From Disorder
http://www.fooledbyrandomness.com/pebbles.pdf
If you do decide to put 85% of your money in cash accounts, you will potentially be working until 80, forget about retirement all together because a inflation will be eating your purchasing power year in and year out. You have to balance it out no matter how you look at it.