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‘Barbell’ strategy can pump up your portfolio

Lifting weights is generally good for your fitness regime. But could a barbell strategy also help you manage your equity portfolio?

The barbell investing approach calls for buying the three top-performing sectors and three bottom-performing sectors from the previous year, according to data from the New York-based investment research firm CFRA.

The company’s figures show that, between 1991 and 2017, combining what is essentially a momentum strategy (owning the top three sectors) and a value approach (buying the bottom three) would have produced a return of 10.7 per cent annually, including dividends. By comparison, buying and holding the S&P 500 index would have averaged 10.3 per cent per year.

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The combined strategy also outpaced either approach on its own, with momentum-only averaging 10.3 per cent, and value yielding 10.4 per cent annually over the same span.

In an ever-expanding universe of ETFs, the barbell approach is an attractive proposition.

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The combined strategy also outpaced either approach on its own, with momentum-only averaging 10.3 per cent, and value yielding 10.4 per cent annually over the same span.

In an ever-expanding universe of ETFs, the barbell approach is an attractive proposition, says Craig Ellis, a portfolio manager with Bellwether Investment Management Inc. in Toronto.

“It’s particularly interesting because it is so easily executable for do-it-yourself investors who now have access to ETFs for virtually every sector in the market,” he says.

But whether the strategy is worth implementing is debatable, Mr. Ellis notes.

He points out that the research did not take into account trading costs, taxes or management fees. These outlays likely would have weighed more heavily on the barbell approach, which, by its nature, requires more turnover of investments resulting in more commissions. It could also lead to more taxes on capital gains, unless, of course, it is used inside a tax-sheltered account such as a registered retirement savings plan (RRSP) or tax-free savings account (TFSA).

Also, sector-focused ETFs typically have higher fees than broad-based index ETFs, Mr. Ellis adds.

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Still the barbell investment plan has its advantages.

For one, the strategy is straightforward and easy to implement with low-cost ETFs, says David Kletz, a portfolio manager with Forstrong Global Asset Management Inc. in Toronto.

“It does not require any fundamental screening and analysis of the underlying individual equity constituents, while still incorporating elements of value and momentum factors,” he says.

As a multi-factor approach it may also be more resilient than single-factor stratagems. Certainly its track record of modest success speaks to its ability to roll with the market’s ups and downs slightly better than the other approaches.

Yet Mr. Kletz cautions the barbell plan is not a pure multi-factor strategy because the investor blindly buys the top three and worst three performing sectors rather than using more refined metrics to determine momentum and value.

Winnipeg investment advisor Darrell Gebhardt agrees the strategy can be misleading in this respect.

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“You might assume it would involve buying high-beta stocks and low-beta stocks, even though it’s really not the case,” says Mr. Gebhardt, portfolio manager at Bieber Gebhardt Advisory Group with National Bank Financial Wealth Management.

Selecting the bottom three sectors does not necessarily equate to buying low volatility –or low-beta – stocks, he says. Nor does buying the top three performers mean you’re buying high-beta stocks with the potential to outperform the broader market.

With a barbell strategy, he adds, “you could end up buying the best performing three sectors and the worst performing three sectors, but the risk profile of all of them could be quite similar.”

The strategy has other issues, too, including overconcentration risk, Mr. Kletz says.

Diversifying across asset classes, regions and sectors creates a more robust portfolio and bolsters risk management, he says. But a barbell strategy involves targeting certain sectors while excluding others, which could increase portfolio volatility because you essentially hold more stocks of a similar nature in a smaller number of baskets.

Mr. Kletz further notes the strategy has no “sanity check” to stop you from buying an overvalued, expensive sector or one that is undervalued because its prospects for profitability are indeed as dim as the market deems them to be.

Mr. Ellis argues that by combining two divergent strategies you also run the risk that they will cancel each other out and your “portfolio becomes very much like the market” only now you’re paying more in fees, commissions and possibly taxes.

Despite the words of caution, barbell strategies do have their place in portfolio management, Mr. Gebhardt says. “Typically we use them with bonds,” he says, buying short- and long-duration bonds to mitigate interest-rate risk.

By comparison, the three-up/three-down strategy for equities is more of a “risk-on” approach than one aimed at reducing risk.

What’s more is it requires discipline to properly execute over time. “When there is a ‘black swan’ event, where every theory seemingly gets thrown out the window, do you have the ability to stick to your plan?” Mr. Gebhardt says.

Even if you can, he says, the fact the barbell approach only beat the buy-and-hold portfolio by 0.3 per cent per year makes one wonder whether it’s worth the trouble.

“Now if it were 2.5 per cent per year,” Mr. Gebhardt says, “ then that would be pretty meaningful.”

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