Higher-for-longer appears to be the path the Federal Reserve will pursue over the near term. So advisors and investors may want to consider some tried-and-true methods regarding accessing the bond market. Those include the barbell strategy.
In a bond barbell, investors mix bonds with various yields and maturities to potentially add some cushion against interest rate risk while capitalizing on income opportunities. It’s a strategy made easier with exchange traded funds. In the current environment, the WisdomTree Floating Rate Treasury Fund (USFR) and the WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY) could be practical options for a fixed income barbell.
It’s likely that rates will remain elevated for some time. So a hypothetical AGGY/USFR barbell would tilt heavily in favor of the latter ETF. After all, the $17.38 billion USFR sports an effective duration of just 0.02 years. Even with that relatively benign rate risk, the ETF still features a solid 30-day SEC yield of 5.34%.
Bond Barbells Offer Flexibility
A primary advantage of a bond barbell is the flexibility gained by the investor implementing the strategy. For example, in an AGGY/USFR barbell, the investor accesses the benefits of a short duration fund via USFR. That simultaneously positions them for the possibility longer-dated bonds will rise in advance of Fed rate cuts via AGGY.
That methodology “allows investors the flexibility to begin adding duration in a deliberate fashion while still taking advantage of the income available in the ultra-short/short portion of the inverted yield curve,” noted Kevin Flanagan, WisdomTree head of fixed income strategy. “The ‘adding duration’ aspect is designed to not only begin locking in yield outside of shorter-dated maturities, but also offers the ability to try and take part in a bond market rally if rates were to reverse course and fall again.”
In a hypothetical example, Flanagan proposes a 70% USFR/30% AGGY barbell. That would provide investors with flexibility and a buffer against interest rates remaining higher longer than anticipated.
“A 70 (USFR)/30 (AGGY) allocation provides a yield to worst of 5.37%, while bringing duration to just under two years (1.97). To sum up, this hypothetical barbell potentially offers a yield advantage of almost 50 basis points versus the benchmark Agg, but with only one-third of the duration risk,” he pointed out.
With a barbell, investors don’t have to make a specific bet on Fed policy. That can often be a fool’s errand. But they do get the benefits of a methodology that’s battle-tested.
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