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Hugo Roque
Hugo Roque
Articles (31) 

Nassim Taleb's Portfolio Approach: The Barbell Strategy

Hoping for the best but preparing for the worst

January 24, 2019 | About:

One of the approaches put forward by Nassim Taleb to achieve antifragility is the barbell strategy.

A barbell is a piece of exercise equipment consisting of a long bar with weights attached at each end. In finance the barbell strategy is typically associated with a fixed-income portfolio management strategy, in which half the portfolio is made up of long-term bonds and the other half of very short-term bonds.

Taleb presents the barbell strategy as a bimodal attitude of exposing oneself to extreme outcomes: one extremely risk averse and another very risk loving, while ignoring the middle. The objective of the strategy is to limit downside and to get exposure to extreme upside outcomes. The possible outcomes are more certain, and the risk of exposure to “black swan” events is much smaller.

As examples of this bimodal attitude, Taleb refers to a number of dual activities that have in common the fact that one is very safe and the other is very risky: an insurance company employee who simultaneously is a writer (Kafka), an active and adventurous life followed by philosophical withdrawal to write and meditate (Seneca), a day job as a trader and free-time scholar (Taleb himself).

Barbell strategy in value investing

The Barbell strategy is a concept that speaks closely to any value investor and that can be applied with different perspectives.

On investment asset classes: When starting an investment financial portfolio, investors can typically choose between cash, bonds or stocks. People tend to be more comfortable with a portfolio with some exposure to bonds (normally 50%), because it reduces the variability.

But bonds are exactly the risky middle that we are here talking about. The investor is guaranteed a small return (the coupon) but still faces the risk of a 100% loss in case of bankruptcy. David Swensen (Trades, Portfolio) has defended this argument in the book “Unconventional Success.” Exposure to medium- to long-term bonds should be avoided.

We know that, in the long term, stocks are the best asset class to own in a portfolio and also the safest, because they are the one that better protects the investor’s buying power over time. Of course, over time, an investor can run out of ideas to invest in stocks. In that situation, cash or short-term securities are the best choice to protect the portfolio. This dual combination of managing cash and getting exposure to substantial upside through the investment in stocks is a barbell strategy.

On stock selection: Margin of safety is the value investing first tool to take care of downside. But in selecting investments, there are multiple available strategies that can be used: quality investing, deep value, sum-of-the-parts, jockey stocks, small stocks, special situations, equity stubs and so forth. Trying to reconcile, within a portfolio, more safe strategies (like quality investing that should provide more stable income streams and consistent growth prospects) and more risky strategies (like small caps that should provide exposure to very high potential ideas, but also the occurrence of more investment errors) is a barbell strategy that has delivered extraordinary returns to superinvestors like Peter Lynch.

On business management: Truly great managers understands antifragility.

Jamie Dimon focuses on building a fortress balance sheet so that JPMorgan is prepared for the worst but continues to invest and hopes for the best. Jeff Bezos tries every day to enlarge the moat of his retail business. That will protect the business for the long term. That is safe. But it doesn’t stop him from investing in other ventures, by trial and error, trying to get another home run like Amazon Web Services.

Alphabet’s management has always maintained a cash-rich balance sheet necessary to support the investment needs of its search business. But the company also thinks ahead about what could be its growth engine 10 or 20 years from now. “Other Bets” is the company’s unit for very risky ventures (such as Waymo) that have the potential to produce extraordinary outcomes.


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