What's the difference between a barbell and a bullet bond portfolio, and why does convexity matter for this choice?
I keep seeing barbell vs bullet comparisons in my CFA Level I Fixed Income materials. Both can have the same duration, but apparently one has more convexity. Can someone explain why this matters and when you'd prefer one over the other?
The barbell vs bullet debate is a cornerstone of fixed income portfolio construction. Both strategies can target the same duration but they behave very differently when yields change.
Definitions
- Bullet portfolio: Concentrated in bonds maturing around one target date (e.g., all bonds maturing in 6-8 years)
- Barbell portfolio: Split between short and long maturities (e.g., 2-year and 15-year bonds), with nothing in the middle
- Ladder portfolio: Evenly spread across maturities (for reference)
Why the Barbell Has Higher Convexity
Convexity measures the curvature of the price-yield relationship. A key mathematical property: convexity increases with the dispersion of cash flows around the duration point.
The barbell has cash flows far from the center (at 2 years and 15 years), giving it high dispersion. The bullet has cash flows concentrated near the center (around 7 years), giving it low dispersion.
Numerical Comparison — Eastwood Capital Allocation
| Metric | Bullet (7y bonds) | Barbell (2y + 15y) |
|---|---|---|
| Modified Duration | 6.2 years | 6.2 years |
| Convexity | 48 | 95 |
| Yield (carry) | 4.80% | 4.55% |
Performance Under Different Scenarios:
For a parallel 100 bp rate shift:
- Bullet price change: -6.2% + 0.5(48)(0.01)^2 = -5.96%
- Barbell price change: -6.2% + 0.5(95)(0.01)^2 = -5.73%
The barbell outperforms by 23 bps due to higher convexity. This advantage is symmetric — the barbell also outperforms for a 100 bp rate decrease.
The Tradeoff: Convexity vs Carry
Higher convexity isn't free. The barbell typically has a lower yield because:
- Short-end bonds yield less (normal yield curve)
- The market prices in the convexity advantage
So the bullet earns 25 bps more carry per year. Over time, if rates don't move much, the bullet's higher carry outweighs the barbell's convexity advantage.
When to Choose Each:
- Barbell: When you expect large rate moves (volatile environment) — the convexity benefit kicks in for big moves
- Bullet: When you expect rates to remain stable — higher carry with no need for convexity protection
- Barbell also better for: Non-parallel shifts (flattening or steepening) since you have exposure at both ends
Exam Tip: The CFA exam loves asking which portfolio outperforms for large parallel shifts (barbell wins) vs small or no shifts (bullet wins due to carry).
Explore portfolio construction strategies in our CFA Fixed Income course.
Master Level I with our CFA Course
107 lessons · 200+ hours· Expert instruction
Related Questions
What exactly is the Capital Market Expectations (CME) framework and why does it matter for asset allocation?
How do business cycle phases affect asset class return expectations?
Can someone explain the Grinold–Kroner model step by step with numbers?
How do you forecast fixed-income returns using the building-blocks approach?
PPP vs Interest Rate Parity for forecasting exchange rates — when do I use which?
Join the Discussion
Ask questions and get expert answers.