Barbell Bond Portfolio: Strategy, Benefits & Risk

A barbell bond portfolio is an investment portfolioInvestment PortfolioAn investment portfolio is a set of financial assets owned by an investor that may include bonds, stocks, currencies, cash and cash equivalents, and commodities. Further, it refers to a group of investments that an investor uses in order to earn a profit while making sure that capital or assets are preserved. that comprises both short-term and long-term bonds wherein one half of the portfolio consists of short-term bonds and the other half consists of long-term bonds.

The investment portfolio is called the barbell bond portfolio because it can be graphically described using a barbell with short-term bonds on one side and long-term bonds on the other. The short-term bonds generally have a maturity period of less than or equal to five years, while the long-term bonds generally have a maturity period of 10 years or longer.

Summary

• A barbell bond portfolio is an investment portfolio that comprises both short-term and long-term bonds wherein one half of the portfolio consists of short-term bonds and the other half consists of long-term bonds.
• Short-term bonds generally have a maturity period of up to five years, while long-term bonds have a maturity period of 10 years or longer.
• The key behind a barbell bond investing strategy is close attention to the short-term bonds in a rising yield curve environment. As the short-term bonds keep maturing, they are reinvested into new short-term bonds, increasing the overall value of the investments and the value of the portfolio.

How Does the Barbell Bond Investing Strategy Work?

The barbell bond investing strategy, simply referred to as the barbell strategy, involves investing in two distinct kinds of bonds – short-term and long-term. The strategy aims at benefiting from both extremes to make a profit. The key in a barbell bond investing strategy is close attention to the short-term bonds in a rising yield curveYield CurveThe Yield Curve is a graphical representation of the interest rates on debt for a range of maturities. It shows the yield an investor is expecting to earn if he lends his money for a given period of time.  The graph displays a bond's yield on the vertical axis and the time to maturity across the horizontal axis. environment.

As the short-term bonds keep maturing, they are reinvested into new short-term bonds, increasing the overall value of the investments and increasing the value of the portfolio. Because of the constant focus on short-term bonds, this is an active strategy, implying that it needs active management to adequately roll short-term bonds into new issues upon maturity.

Another important aspect of the barbell portfolio is timing. The best time to invest using a barbell strategy is when the yield curve is flattening. A flat yield curve implies a very small variation or disparity in the yield between short-term and long-term bonds. Therefore, the varianceVariance FormulaThe variance formula is used to calculate the difference between a forecast and the actual result. or spread between bonds is very small, which works best for the barbell strategy.

On the contrary, a steepening yield curve is detrimental to a barbell strategy since long-term yields increase faster and at an increasing rate as opposed to short-term yields. It results in a decline in the overall value of long-term bonds, thus defeating the entire purpose of the barbell strategy. Therefore, the best time to invest using a barbell strategy is when the yield curve is flattening.

Barbell Bond Portfolio Investment – Features

1. Two types of bonds

The barbell bond portfolio only contains two types of bonds – either short-term or long-term bonds. The bonds have similar maturity timelines. There are no bonds with an intermediary maturity period.

2. Risk level

The exposure to risk using a barbell strategy primarily lies in the long-term bonds of the portfolio. The long-term bonds are untouched up to maturity and are much more volatile than short-term bonds. The risk comes in the form of potential capital losses on account of unfavorable market conditions.

3. Active strategy

The barbell investing strategy is an active investment strategy. It requires active monitoring of the short-term bonds since the essence of the strategy is to roll short-term bonds into new ones upon maturity. Without active management, this investment portfolio will only end up with long-term bonds, defeating the very purpose of the barbell strategy.

4. Higher liquidity

Since this investing strategy involves rolling short-term bonds into new issues upon maturity, it offers higher flexibility and liquidityLiquidityIn financial markets, liquidity refers to how quickly an investment can be sold without negatively impacting its price. The more liquid an investment is, the more quickly it can be sold (and vice versa), and the easier it is to sell it for fair value. All else being equal, more liquid assets trade at a premium and illiquid assets trade at a discount. compared to other investing strategies.

Related Readings

CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)® Program Page - CMSAEnroll in CFI's CMSA® program and become a certified Capital Markets &Securities Analyst. Advance your career with our certification programs and courses.certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

• Investment PortfolioInvestment PortfolioAn investment portfolio is a set of financial assets owned by an investor that may include bonds, stocks, currencies, cash and cash equivalents, and commodities. Further, it refers to a group of investments that an investor uses in order to earn a profit while making sure that capital or assets are preserved.
• BondsBondsBonds are fixed-income securities that are issued by corporations and governments to raise capital. The bond issuer borrows capital from the bondholder and makes fixed payments to them at a fixed (or variable) interest rate for a specified period.
• VolatilityVolatilityVolatility is a measure of the rate of fluctuations in the price of a security over time. It indicates the level of risk associated with the price changes of a security. Investors and traders calculate the volatility of a security to assess past variations in the prices
• Term to MaturityTerm to MaturityTerm to maturity is the remaining life of a bond or other type of debt instrument. The duration ranges between the time when the bond is issued until its