The Barbell Story: the next blockbuster in the making?

As we dive deeper into 2024, the story that could resonate with investors is the “Barbell” story.

Much like Barbie’s struggle with living in her comfort zone before she eventually ventured into the real world, in 2024 we have observed that some investors continue to stay in their comfort zone and holding onto cash, without considering the realm of higher yielding possibilities out there.

Now, one may ask, “If cash is no longer king, then where would I look for opportunities, especially when valuations in many markets are looking so high? Besides, how can I tell when central banks will turn from hawk to dove?”

Well, this is where the “Barbell story” comes in.

And core to it is what we call a “duration barbell strategy” that can potentially help navigate the above uncertainties.

The long and short of the Barbell Strategy

In a nutshell, a duration barbell strategy involves gradually rotating out of cash into high quality, long and short duration bonds.

This strategy entails an allocation to both ends of the bond duration spectrum to capture both the relatively high yields of short-term bonds² and the capital appreciation potential of longer-term bonds when interest rates fall. Ideally, both ends of the “barbell” should be well diversified, with portfolio durations of the short and long ends being, for example, less than one year, and more than five years, respectively.

Like the aforementioned blockbuster movie, the journey of a duration barbell strategy is a three-act story that involves transitioning from the stage of uncertainty to exploration, and ultimately ushering in new opportunities for growth:

Act 1: Being cognisant and making the most of the flat yield curve

While peak inflation and peak rates in the United States are likely in the rearview mirror now, uncertainty remains with regards to the timing and magnitude of potential rate cuts by the Fed this year. Therefore, accurately timing a move into a longer duration bond portfolio can prove tricky, even to the most sophisticated investors.

Our story explores this viewpoint, given that, with a well-diversified, high quality investment grade mix of short duration bonds, interest rate sensitivity is reduced without compromising on yield. This is the benefit of a flat yield curve, so why not make the most out of it?

Consider this: The yield on the US Treasury 3-month bill reached 5.51% in October 2023, the highest since January 2001 (more than 23 years ago!), and we are not too far from there, at 5.38% as of 29 February 2024³ . How much return does one get today by staying in cash?

Act 2: Exploring longer duration bonds

With the short end of the barbell now sorted, what do we do about the other end? Going back to basics, bond prices go up when interest rates go down. Moreover, the longer the duration, the larger the price movement. Consequently, a longer duration bond portfolio (say five to ten years duration) stands to benefit more from greater price appreciation potential. Cash, on the other hand, well, just remains as cash, unless you rotate out of it.

To illustrate; when interest rates go down by 1%, a bond portfolio with a duration of one year will experience a capital gain of approximately 1% as well. If the same bond portfolio had a duration of five years instead, the capital gain would be around 5%. The longer the duration, the larger the capital gain when interest rates decrease.

Now, in addition to extending duration, we can also explore further and achieve other outcomes concurrently. For example, using a Singapore dollar bond portfolio to minimise currency risk, or accessing a bond portfolio from other regions with better growth potential, such as India. We can even go for a globally diversified lower carbon corporate bond portfolio. As you can see, the options are plentiful.

Act 3: End of the journey: Leveraging potential rate cuts

It is always good to have an end goal to move towards, but it is the journey itself that matters the most.

So, here we are at the final stretch of the “Barbell” journey; let us look at the ground that has been covered so far: Firstly, accepting uncertainty and exploring opportunities. Secondly, having exposure to a short duration bond portfolio to kick-start the barbell. Next, completing the other side of the barbell by adding exposure to a longer duration bond portfolio.

What about the last stop of the journey, when central banks start cutting rates? While there is no crystal ball to tell us when, and by how much, these interest rate cuts will occur, having a duration barbell strategy in place can prepare us well. If interest rates do not fall as fast as expected, the short end still provides compelling yield. If interest rates fall as expected or faster, the long end captures the capital appreciation.

It took Barbie over 60 years to make the jump onto the silver screen and for audiences to embrace her story. Without having to wait that long, we believe one can embark on an exciting journey of discovery and new possibilities of their own by embracing the “Barbell” story.