Two strategies to manage a bond portfolio:

There are generally 2 strategies to manage a bond portfolio:

A very conservative approach to portfolio structure is called "Ladder strategy". It involves dividing your money among bonds with different maturities, primarily short to intermediate to long.

You might buy for example, a three-year bond, a five-year bond, a ten-year bond, a thirty-year bond. You would put approximately equal amount of money in each bond. As each bond matures, you would replace it with a bond equal to the longest maturity in your portfolio.

By doing that, the average maturity of such a portfolio is about half of the longest maturity.

The ladder strategy protects you against a variety of risks:
- Keeping average maturity of the portfolio short to intermediate protects the principal value of the portfolio against interest rate risk.
- Holding your bonds until maturity will be redeemed at par. If interest rate goes up, you will be investing maturing bonds at high rates and you will thereby boost total return.

The other strategy is called "Barbell strategy". A barbell portfolio derives its name from the fact that approximately half of the portfolio is in short term (under 2 years) and the other half in long term bonds (20 to 30 years).

Investors will go for barbell strategy primarily if they think interest rate are about to decline at the long end. If that happens, the longer term bonds appreciate in value.

=> If they have predicted correctly, this gives them the opportunity to boost total return by selling the longer term bonds and realising the capital gains.
=> If they are wrong, at least they would have hedged their bets because the shorter maturities act as a cushion.


Source: The Bond Book by Annette Thau