Derek Horstmeyer, PhD
Derek Horstmeyer, PhD professor of finance at George Mason University’s Business School, Fairfax, Virginia.
DerekHorstmeyer.com
If you want to pump up your portfolio returns in the current market environment, try a barbell strategy. How it works: You invest in two extremes of a similar asset class while avoiding middle-of-the-road choices. Barbell strategies have a long history of improving performance in rising-interest rate environments such as the one we’re in now.
Example: Instead of an S&P 500 ETF, split your money between an S&P 500 value ETF that tracks companies with low price-to-earnings ratios (P/Es)…and an S&P 500 growth ETF that owns firms with high P/Es. Since 1980, when the Federal Reserve has raised short-term interest rates, this barbell strategy has averaged annual returns of 1.4 percentage points more than the S&P 500. Reason: During uncertain times, investors tend to stick with broad market indexes for a sense of safety. But in these markets, both value stocks and growth stocks tend to be mispriced. A barbell strategy can exploit that difference.
Also keep in mind…
Barbell strategies do better for bond investors in rising-rate environments. Examples: A portfolio of 50% high-yield bonds and 50% money-market instruments outperformed a portfolio of 100% intermediate credit-quality bonds by about 2.3 percentage points a year.
When interest rates were decreasing, barbell strategies underperformed their benchmarks. Examples: The stock valuation portfolio returned 0.01 percentage points less than the S&P 500 a year…the high-yield bond/money-market portfolio, 4.9 percentage points less than intermediate credit-quality bonds.