From a defensive investment stance, cash was king in 2023. In entertainment, Barbie reigned supreme. The movie made a billion dollars within three weeks of its release and became the highest-grossing film last year, captivating audiences worldwide.
In 2024, however, the “Barbell” story emerges as a narrative potentially significant for investors.
Like Barbie’s struggle to leave her comfort zone before exploring the real world, some investors are hesitant to move beyond cash holdings, missing out on potentially higher-yielding opportunities this year.
Now, one may ask, “If cash is no longer king, then where would I look for opportunities, especially when valuations in many markets are 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. The core to it is what we call a “duration barbell strategy” that can potentially help navigate the above uncertainties.
The Barbell Strategy
In a nutshell, a duration barbell strategy involves gradually rotating out of cash into high quality, long and short duration bonds.
See also: US equities, IG, fixed income strategies, gold and copper among top investment picks: UBS
This strategy entails allocating to both ends of the bond duration spectrum to capture the relatively high yields of short-term bonds 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 blockbuster mentioned above, the journey of a duration barbell strategy is a three-act story that involves transitioning from uncertainty to exploration and ultimately ushering in new growth opportunities:
Act 1: Being cognisant and making the most of the flat yield curve
While peak inflation and peak rates in the US are likely in the rearview mirror now, uncertainty remains regarding 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.
See also: With Trump win boosting stocks, investors hunt for next winners
Our story explores this viewpoint, given that a well-diversified, high-quality investment-grade mix of short-duration bonds reduces interest rate sensitivity without compromising on yield. This is the benefit of a flat yield curve, so why not make the most of it?
Consider this: The yield on the US Treasury three-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 Feb 29. How much of a return does one get today by staying in cash?
Act 2: Exploring longer duration bonds
Now that the short end of the barbell strategy is addressed, attention turns to the other end. Going back to basics, bond prices rise as interest rates fall. 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. On the other hand, cash remains as cash unless you rotate out of it.
When interest rates go down by 1%, a bond portfolio with a duration of one year will also experience a capital gain of approximately 1%. If the same bond portfolio lasted five years instead, the capital gain would be around 5%. The longer the duration, the larger the capital gain when interest rates decrease.
In addition to extending the duration, we can explore further and achieve other outcomes concurrently. For example, we can use a Singapore dollar bond portfolio to minimise currency risk or access 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: Leveraging potential rate cuts
It is always good to have an end goal to move towards, but the journey itself matters the most.
Here we are at the final stretch of the “Barbell” journey; let us look at the ground that has been covered so far: First, accept uncertainty and explore opportunities. Second, have exposure to a short-duration bond portfolio to kick-start the barbell. Next, complete the other side of the barbell by adding exposure to a longer duration bond portfolio.
For more stories about where money flows, click here for Capital Section
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 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 a compelling yield. If interest rates fall as expected or faster, the long end captures the capital appreciation.
It took Barbie over 60 years to jump onto the silver screen and for audiences to embrace her story. Without waiting that long, we believe one can embark on an exciting journey of discovery and new possibilities by embracing the “Barbell” story.
William Goh is fixed income portfolio manager at HSBC Asset Management (Singapore) and fund manager of the HGIF Singapore Dollar Income Bond Fund
