Bond investors today must tangle with a long list of potential hazards: rising interest rates, stretched valuations, divergent credit cycles, global political change. Managing a fixed-income portfolio in this environment requires constant attention to interest-rate and credit risk—and the interplay between the two.
That interplay has always existed. But understanding it is especially critical as markets emerge from nearly a decade of post-crisis conditions and extraordinary monetary policies. In this paper, we’ll look at how pairing interest-rate-sensitive bonds and growth-sensitive credit assets in a single fixed-income portfolio—and letting managers adjust the balance as conditions and valuations change—can provide high and steady income while minimizing downside risk.
This credit barbell approach often works well because it blends assets whose returns are usually negative correlated. Growth-oriented assets such as high-yield bonds and interest-rate-related ones such as high-quality government bonds tend to take turns outperforming each other (Display). This allows investors to sell the outperformers on one side and buy the underperforming bonds on the other.
There’s more than one way to build a credit barbell, of course. We’ll look at how investment weights, leverage ratios and asset mixes can vary. And we’ll explain why it takes an active, hands-on approach to manage the barbell effectively as market conditions shift.