Credit Duration Barbell: Optimizing Risk for Income Generation

Source: FactSet, as of 12/31/24.

This Bloomberg Aggregate Index declined over 7% in the three-year period ending December 31, 2024. During the same period, long-duration Treasuries lost almost 35%. Meanwhile, intermediate and long-duration bond funds saw massive inflows. Rate calls are difficult to predict, and there is a significant penalty for being wrong on the long side.

This highlights the importance of diversification in fixed income — with so many different potential outcomes, portfolios should be positioned so they are not dependent on one specific outcome to perform well.  We believe implementing a “credit/duration” barbell consisting of short-duration, non-investment-grade credit and longer-duration, investment-grade bonds can achieve that necessary diversification.

The credit component can be represented by short-duration high yield or bank loans — in our example, we use an equal weighted blend of both. For simplicity, we use the Bloomberg Aggregate Bond Index for the high-quality duration component. Short-duration credit historically generated relatively high levels of income and is more sensitive to economic conditions and corporate fundamentals.  Historically, when credit experienced volatility, this coincided with falling rates, positively impacting longer-duration, high-quality bonds. Pairing these uncorrelated segments of fixed income together has the potential to provide competitive risk-adjusted returns with lower volatility.

An investor’s economic view and risk tolerance would determine how the barbell is constructed. A barbell tilted toward credit has the potential for high levels of income and total returns. If the economy is weaker than anticipated, high-quality duration can buffer credit volatility. On the other hand, an investor who wants to lengthen duration and is more cautious on credit may tilt the allocation toward higher-quality, longer-duration bonds, while maintaining some credit exposure, which may enhance returns if rates don’t fall. As shown below, an equally weighted barbell benefited from rate exposure in 2020 and from credit exposure over the last few years.

Figure 2: Credit/Duration Barbell

Definitions

Duration is a measure of the sensitivity of a fixed-income investment, such as a bond or a bond portfolio, to changes in interest rates.

Standard deviation is a statistic measuring the dispersion of a dataset relative to its mean.

Core Bonds are a category of fixed-income securities that form the foundation of a diversified bond portfolio. They typically consist of relatively stable and low-risk bonds and are fundamental to building a balanced investment portfolio.

The Credit Duration Barbell is a portfolio strategy that combines credit exposure (typically non-investment-grade bonds) and duration (usually higher-quality, investment-grade bonds) to achieve diversification and manage risk. This strategy involves balancing the credit quality and maturity profile of bond investments.

The Bloomberg U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment- grade, U.S. dollar-denominated, fixed-rate, taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities (agency fixed-rate and hybrid adjustable-rate mortgage pass-throughs), asset-backed securities, and commercial mortgage-backed securities.

The Morningstar LSTA U.S. Leveraged Loan Index is a broad index designed to reflect the performance of U.S. dollar facilities in the leveraged loan market. Index results assume the reinvestment of all capital gain and dividend distributions.

ICE BofA US High Yield BB-B (1-5Y) tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market.

About risk

Bonds are subject to interest-rate risk and can lose principal value when interest rates rise. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner, or that negative perception of the issuer’s ability to make such payments may cause the price of that bond to decline.

Diversification cannot assure a profit or protect against loss in a declining market.

Important disclosures

This material contains the opinions of its authors but not necessarily those of New York Life Investments or its affiliates. It is distributed for informational purposes only and is not intended to constitute the giving of advice or the making of any recommendation to purchase a product. The opinions expressed herein are subject to change without notice. The investments or strategies presented are not appropriate for every investor and do not take into account the investment objectives or financial needs of particular investors.

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