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A barbell approach uses the two ends of the investing spectrum – highly conservative and super aggressive – in an attempt to maximize gains while limiting downside risk.

iStock photo

What investment strategy should you use during a lengthy period of market turbulence? Warren Collier, managing director of BlackRock Canada, which owns the iShares ETFs, suggests taking a "barbell" approach when selecting your securities.

It's a strategy that runs counter to mainstream thinking, which focuses more on obtaining decent risk-adjusted returns by building a portfolio of middle-of-the-road securities, such as balanced funds. In contrast, a barbell approach uses the two ends of the investing spectrum – highly conservative and super aggressive – in an attempt to maximize gains while limiting downside risk. The strategy has been described as putting all your eggs in two baskets.

Many investors are familiar with the barbell strategy as it applies to fixed-income securities, where it is most commonly used. In this case, the portfolio would be divided between short-term bonds with maturities of five years or less (low return, low risk) and long-dated issues with maturities of 10 years and more (high potential return, high risk), with virtually nothing in between. The amount of risk can be controlled by varying the percentage allocations – for example a very safe approach would be to invest 90 per cent of the assets short-term and 10 per cent long-term.

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If the securities in the portfolio are individual bonds, this approach requires close attention because as the short-term bonds mature they have to be replaced. Using ETFs or mutual funds makes it simpler because they have no maturity dates, although the securities they hold do.

But what about the equity side of a portfolio? Mr. Collier suggests one side of the barbell should focus on core exposure to stock markets at the lowest possible cost. Although he did not mention specific securities, this would suggest using funds like the iShares Core S&P/TSX Capped Composite ETF (TSX: XIC) and the iShares Core S&P 500 Index ETF (TSX: XUS) for the left side of the barbell. At the other end, he suggests using high quality, actively managed funds to add value. These would not be ETF products but rather mutual funds from proven companies such as Mawer and Beutel Goodman.

One important component of portfolios right now is Japan. Despite the strong performance of the Tokyo Nikkei 225 Index so far in 2015 (it was up 13.3 per cent for the year as of the end of last week), Mr. Collier feels there is more upside potential.

In a recent newsletter, BlackRock's investment team wrote: "Although the economy is running at a lackluster pace, Japanese companies are growing earnings faster than anywhere else in the world.

"This bodes well for Japanese equities, as dividends and return on equity rise. Valuations are still cheap despite the strong outperformance so far this year. Furthermore, the Bank of Japan seems ready to boost its quantitative easing measures if the economy were to miss the bank's inflation goals. Such a move would likely weaken the yen, though looser monetary policy would be a boon to Japanese equities."

The iShares Japan Fundamental Index ETF (CAD-Hedged) (TSX: CJP) was showing a one-year total return of 31.3 per cent as of the end of June. It consists of companies that have historically had a good dividend record, strong free cash flow, and increasing sales. Top names include Toyota, Honda, and Mitsubishi Financial.

Up-and coming rival Vanguard Canada does not have a dedicated Japan ETF but the Vanguard FTSE Developed Asia Pacific ETF (TSX: VA), which invests in the U.S.-based Vanguard FTSE Pacific ETF, holds about 60 per cent of its assets in Japan. It gained about 17 per cent in the past 12 months.

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Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, click here. Follow Gordon Pape on Twitter and on Facebook.

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