Whether or not you’ve read Nicholas Nassim Taleb (of Black Swan fame), you’ve probably come across the barbell concept. The strategy has gained prominence ever since Taleb’s book, and the Global Financial Crisis in ’08 that visibly demonstrates his point about unpredictability, and existing financial biases. While the barbell concept is more nuanced than can be discussed in one short article, I’ll attempt to explain the basics here, and you can ask your wealth manager if it’d work for you:
What is a barbell strategy?
Picture the kind of barbell you’d use at a gym: the weights are on either end of the bar, with nothing being placed in the middle of the bar. That’s roughly analogous to a “barbell” portfolio, where the assets are binary: they are either very low risk, or very high risk, with nothing in between.
A typical (but not universal) example of a barbell strategy would be one where 90 per cent of the portfolio is in low-return, risk-free assets, while the remaining 10 per cent are in high-return, high-risk assets. For example:
In a portfolio of $3 million, the barbell investor may have $2.7 million in assets like US 3-month T-Bills, German or Swiss government bonds, or even your plain old CPF accounts.
The remaining $300,000 however, could be in high-risk, high-return assets like emerging market high-yield bonds, or high-interest P2P loans to start-ups.
Your wealth manager, when resorting to Wall-Speak babble, will possibly refer to these as low and high-beta assets.
Low beta assets are those with low correlation to market movements (e.g., your CPF interest rate is guaranteed, so will have low to no volatility when measured against any index). High beta assets, on the other hand, move in greater leaps than the overall market. A beta of 2, for example, could mean that for every $1 the market is up or down, your asset will be down by $2.
In some cases, the risky assets may even have an inverse relationship with the market, where the asset value rises as the market falls. I’ll leave your financial advisor, wealth manager, etc. to explain the further intricacies of these assets, but I trust you get the general idea: a barbell strategy means a portfolio that’s cleanly splut between very safe, and very risky, assets.
Okay, but why would anyone do this?
Let’s use an example where the high-risk asset in question is stocks in medical research companies. These tend to be extremely high-risk, because research might lead to breakthroughs, or it may be a dead-end.
That is, the company may end up with a breakthrough that furthers cures for cancer, stops AIDS, or something like that. In such a scenario, the company will probably see massive leaps in value overnight, and make huge returns for investors.
On the other hand, the company may dunk a few million dollars into a new drug, and discover the only thing it cures you of is having too much money.
If your exposure to this company is 10 per cent, then it’s not enough to derail your portfolio. The other 90 per cent of assets are still chugging along just fine.
If, however, you hit the jackpot, then you would see massively outsized gains from investing in this company…and you would have done so while taking only a 10 per cent risk.
What should you expect from this?
In all probability, long periods of boredom, coupled with a burst of excitement every few decades. Barbell strategies usually show their benefits during periods of intense market volatility. Nicholas Nassim Taleb himself, for example, gained prominence only after he made an absolute killing during the 2008 crisis. Before that, he was relatively unknown.
There is a plethora of reasons for this, but the simplest one is the predictable reaction of governments to a crisis. The US Federal Reserve, for instance, likes to lower interest rates and flood the market with more cash during a crisis. This provides an economic stimulus to speed up recovery, and a “boom” period tends to follow this.
From the perspective of a typical investor however, this means you could go 10, 15, or even 20 years with nothing interesting happening, then a sudden global event causes a huge surge in your portfolio gains.
(There’s an unverified, but popular, saying that markets see recessions once every 10 years. I’ll leave it up to you whether to believe that.)
What are the implications?
Because a lot of this strategy involves waiting for a big event, the investment horizon matters. If you’re a younger investor, you may have more time to play this waiting game. If you’re an older investor, and urgently need to raise your retirement funds because of a late start, this may not be the right approach.
Another factor is your personal risk appetite. Even if the bulk of the portfolio is in safe investments, the high-risk portion of the portfolio may be past the sleeping point of some investors. If you just don’t like the notion of providing venture capital, buying junk bonds, etc., then maybe this isn’t right for you.
Some wealth managers also decry the limited diversification of barbell-type portfolios. The exclusion of medium-risk assets (remember, you only go low or high-risk, with nothing in between) can mean you lose out on having certain unit trusts, medium-risk ETFs, and other conventional assets.
Finally, a barbell strategy is quite different from conventional portfolios. It almost always involves more complex assets, especially on the high-risk end of the portfolio. You also need to understand how the downside risks are capped, via the low-risk assets picked by your financial advisor. This does mean the strategy gets a bit more hands-on, compared to a typical portfolio.
As always, there’s no single investment strategy that’s right or wrong for everyone. Speak to a finance expert on whether barbell investing fits your current financial goals and risk profile. You can also reach out to us on Single Digit Millionaire (insert the CTA here please) with any questions.
