What is a barbell strategy and how do you use it?

It is investing at two ends of the risk spectrum and leaving out the middle–like a physical barbell. Therefore, an investor will buy high-risk securities and low-risk securities and hold no medium-risk securities in their portfolio.

In bonds, this could be done by holding riskier long-term ones on one end and short-duration ones on the other.

In equities, an investor would hold high beta (high volatility) stocks on one end and low-beta stocks on the other.

Why use the strategy?

It might seem like people can predict the market movement, especially when the times are good but that belief gets shaken when hard times come or, worse when an unexpected development sends the market crashing.

Author and mathematical statistician Nassim Nicholas Taleb called such developments black swans to describe the rarity of their occurrence, like spotting a black swan.

Since it is impossible to predict such events, a person— say, an investor—cannot calculate the risks they will have to face (in the stock market) accurately. Therefore, he put forward the idea of anti-fragility to survive such events. The barbell strategy is a way to build anti-fragility into an investment portfolio.

But, what is anti-fragility?

Anti-fragility is the quality that allows an object to expose itself to chaos and either gain extraordinarily from the chaos or not be utterly ruined by it.

An anti-fragile entity can not only survive an extraordinary shock but also grow stronger from it.

You build that quality into portfolios by holding extremely risky bets that give you extraordinary returns when a positive “black swan” event occurs and extreme risk-aversion bets that protect you from the downside when a negative “black swan” event occurs.

For example, if governments across the world decide to transact only in cryptocurrencies, then that could be a positive “black swan” event for an investor who holds these currencies even as a small percentage (say 5 percent) of their portfolio. They can make staggering returns.

On the other hand, if you were a businessperson who started investing in digitilisation of your company’s operations years before the coronavirus pandemic struck, your company may have handled the lockdown far better than its peers and may have even increased its market share during the crisis.

Taleb described anti-fragility as a combination of aggressiveness and paranoia. He wrote, “Clip your downside, protect yourself from extreme harm, and let the upside, the positive Black Swans, take care of itself.”

Also read: What could keep markets volatile this week?

How does DAM Capital’s portfolio use this strategy?

It has built a portfolio that resembles a football team, with three aggressive strikers and three defenders, one of which is the ultimate defender or the goalkeeper. But, it also has versatile midfielders, which would be a variation from the barbell that does not accommodate a middle ground.

The portfolio’s aggressive strikers are Ashok Leyland, TVS Motors and Maruti Suzuki. The auto sector is showing signs of recovery in passenger vehicles, two-wheeler and light commercial vehicle segments, Chakraborty said.

The defenders are Apollo Hospitals and Sun Pharmaceutical and the ultimate defender or goalkeeper is NTPC. These are bets on the stocks and not the sector, he said.

“Healthcare segment is going to see massive demand growth over the next few years. There is a huge addressable market and few players, and Apollo is present pan India and in every segment,” he said.

Sun Pharma, with its healthy balance sheet and specialty drugs, will give a steady growth of about 15 percent, they believe and is available at a reasonable valuation.

NTPC is seeing improvement in growth but, more interestingly, it is going to replicate its entire coal-based capacity into renewable capacity. When compared to international and domestic peers, it is available at a very low valuation, he said.

The midfielders (growth plus value) are Aditya Birla Fashion and Retail (ABFRL), Astral, Gujarat Fluorochemicals, HDFC Bank and ICICI Bank.

“This is the versatile segment, so neither am I playing defensive nor am I playing aggressive,” he said, which is a deviation from the barbell strategy which has no place for medium-risk plays.

These bets have been placed on individual stocks except for HDFC Bank and ICICI Bank, which are plays on banking.

ABFRL because of its asset-light profitability engine, which is Madura Lifestyle and its brands, and reworking of its Pantaloons business, which resulted in its operating margin growing 240bps between FY15-20.

Astral is a fast-growing pipe brand, which can ride the home-improvement trend and has shown the ability to scale in new product categories.

Gujarat Fluorochemicals is a globally competitive player with near-total vertical integration. It has a potential blockbuster product in PVDF, which is a polymer used in lithium-ion batteries and solar panels and it is building electrolyte solutions for EV batteries.

HDFC Bank and ICICI Bank because they believe the Big Four will grab more market share and HDFC Bank will benefit from the rate hike because it has a sizeable portfolio of corporate bonds on a floating rate.

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