Christopher Wood: hold a growth and value “barbell“ portfolio

The spike in coronavirus cases across America may be less concerning than it looks, says veteran analyst Christopher Wood in Greed & Fear, his weekly strategy note. The average age of new cases is falling, while deaths are declining despite rising infections. That may be because increased testing is finding a greater number of cases and more of those cases are younger and healthier people, but it could also imply that Covid-19 is evolving to become less virulent and will burn out. “If such is indeed the case, it is extremely bullish. Investors should certainly keep an open mind on such a possibility.”

However, even if we face a severe second wave of infections, we are unlikely to see a fresh round of global lockdowns. Donald Trump will not countenance shutting down the US as the presidential election draws near, while new outbreaks in Europe are likely to be dealt with by local closures. Instead, “the biggest risk to stocks, especially growth stocks, will come next quarter, when investors will be talking V-shaped recovery and there will be a sudden realisation that monetary policy is too easy”.

Wood suggests a barbell strategy (see below) of holding growth and value stocks. Growth stocks should outperform while concerns about a second wave continue. But once recovery looks likely, cheaper cyclical stocks such as financials, carmakers, energy and basic materials will rally. That should buoy markets in Europe and Japan, which are more weighted towards cyclical stocks than the US.

I wish I knew what a barbell strategy was, but I’m too embarrassed to ask

In weightlifting, a barbell is a long and relatively light metal bar to which heavy weights are attached at both ends. Similarly, a barbell investment strategy means weighting a portfolio towards the two extreme ends of an asset class with nothing in the middle. This generally means the investor ends up with a combination of lower-risk, lower-return and high-risk, higher-return holdings. 

Unlike a real barbell, the amount invested at each end of the portfolio isn’t necessarily the same. For example, you might have 80% in safer assets and 20% in riskier assets, depending on what will produce the best balance of risk and return.

The traditional use of the barbell approach is in bond investing. A bond barbell consisted of very short-term bonds (which offer lower yields but will mature soon and can be reinvested in higher-yielding assets if interest rates rise) and long-term bonds (which lock in higher long-term yields in case interest rates fall, but are more vulnerable if rates rise). This strategy works best when there is a large gap between short-term and long-term yields.

When applied to equities, a barbell often means investing most of the portfolio in low-risk stocks (typically large blue chips in defensive sectors) and the rest in higher-risk stocks with higher potential returns (eg, small caps or emerging markets). Other styles might include income portfolios that combine high-yield stocks with low-yielding ones that grow dividends faster.

A barbell approach can also apply when investing across asset classes as well as within them. One strategy would be to invest much of the portfolio in very safe assets (cash or very short-term government bonds) and the rest in extremely risky assets that have very high potential returns under certain circumstances, but a high likelihood of large losses or ending up completely worthless. These might include distressed stocks, venture-capital investments or options.