The Updated Barbell Strategy
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Financial advisors and investors of fixed income strategies have for a very long time used a tried and tested method to “immunize” or protect a fixed income portfolio from interest rate changes.
The Barbell Strategy basically has a portion of assets held in bonds that are of a certain credit quality placed between a portion that has a short term maturity and a portion that has a long term maturity. The idea is that if interest rates rise, the bonds on the longer term will lose value greater and when the shorter term bonds mature, use the proceeds to buy bonds that have a maturity that is greater than the existing long-term portion.
This is a very involved process for the average investor. Time and effort is made to research bonds and look for credit quality of issuers, maturities of new and existing bonds, rates of returns and other factors. When it comes to existing bonds, the concerns such as yield-to-call, yield-to-maturity, and price premium or discount are added to the list.
Now all of these tasks can be reduced and a simplified approach to attain like goals can be done with fixed income Exchange-traded funds (ETFs). ETFs offer predefined portfolios, transparency, easy of trading and tax efficiency and dividends as part of the total return.
Instead of buying individual bonds to fill each part of the barbell, buying ETFs that have the desired maturity and characteristics takes a lot of the ongoing monitoring and adjustment away from the average investor. A fixed income ETF will hold the desired bonds and the management of the fund will make the necessary adjustments and not have the same undesirable effects that come with an open end bond mutual fund.
The iShares Barclays 1-3 Treasury Bond Fund (NYSEMKT: SHY) is designed to mimic the Barclays Capital 1-3 Year Treasury Index. This passive strategy will automatically adjust the holdings when matured bonds are redeemed into other bonds that fit within this index. SHY can give a consistent short term rate of return that will be sensitive to interest changes and make changes to continue the tracking of the index.
Following this is the iShares Barclays 3-7 Treasury Bond Fund (NYSEMKT: IEI). The structure of this ETF is very similar to SHY, with the exception that the Barclays Capital 3-7 Year Treasury Index is the benchmark for tracking and adjustment purposes.
Taking up the next spot, and surely with no surprise, is the iShares Barclays 7-10 Year Treasury Bond Fund (NYSEMKT: IEF). The pattern of these ETFs is clearly established, with the difference of using the Barclays Capital 7-10 Year Treasury Index as the blueprint to follow.
Applying the barbell to these ETFs will start with approximately one half in SHY and depending on investor needs for return of principal; place the other half in IEI or IEF. Unlike the traditional barbell strategy, SHY will not mature and repay the investor as it is always holding onto bonds per the index.
As an adjustment to this modification, the investor that understands interest rate movements can “tilt” the barbell by moving funds from one side to the other as a way to capture additional profits. As a general rule of thumb, longer term bond values will be affected far more by changes in short term interest rates. This is due to the uncertainty associated with the longer amount of time it will take to be repaid.
This strategy is one of the multitudes that are available. Te astute investor will perform a thorough self inspection into risks, tolerances, and goals before choosing any one that appears to fit the profile.
Jeffrey L. (Jeff) Stouffer is an Investment Advisor Representative and manages the Alexandria VA office of Kingsview Asset Management. As a practicing financial advisor serving the needs of individuals and small businesses, he believes in using a wide range of investment strategies, including alternative investments. All strategies are client centric and unique. He can be reached at jeff.stouffer@kingsviewassetmanagement.com and is available to answer any questions about this combined approach.
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