Derek Horstmeyer, PhD professor of finance at George Mason University’s Business School, Fairfax, Virginia.
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.