Are you underweight the asset class driving the best performing portfolios in the world?

Every few years, markets remind investors that diversification isn’t a static formula. When traditional assets become highly correlated, the appeal of strategies that march to a different beat, such as private credit, infrastructure, real estate, and hedge funds, all come sharply into focus. 

These assets don't behave like the ASX200 or a government bond, and that's precisely the point. But how much of a portfolio should sit there? And, what do they really do for performance and risk?

Around the world, the answer varies. Global investors tend to go further than their Australian peers, reflecting differences in philosophy, access and risk appetite.

Yet the message from the data is consistent: portfolios with alternatives tend to be stronger, more resilient, and less exposed to market shocks.

Rethinking diversification

For decades, investors have relied on the 60/40 mix; 60% equities for growth with 40% bonds as an anchor. But that balance has started to crack. Inflation and rate volatility have pushed stock-bond correlations higher, blurring the safety line between the two. 

According to a CFA Institute study, the correlation between equities and bonds topped 60% in 2022, undermining the idea that one would climb while the other fell. 

Their analysis, The 60/40 Portfolio Needs an Alts Infusion, found that replacing part of a traditional 60/40 portfolio with alternatives materially lifted efficiency. 

A 40/30/30 mix (equities/bonds/alts) improved the Sharpe ratio from 0.55 to 0.75 between 1989 and 2023, while drawdowns fell by roughly 20%. 

Why does the Sharpe ratio matter?

The Sharpe ratio is one of the most widely used measures of risk-adjusted return. It doesn't just show how much a portfolio earned - it shows how efficiently those returns were achieved relative to volatility. 

A higher Sharpe ratio means the portfolio was rewarded more for each unit of risk taken.

In practical terms, this means investors weren’t just getting higher returns by adding alternatives; they were getting those returns with less stress and greater consistency, which is the ultimate goal of portfolio construction.

The Yale model: illiquidity, inefficiency and advantage

Few investors have influenced diversification thinking more than David Swensen, the late CIO of the Yale endowment. In Pioneering Portfolio Management, Swensen argued that true long-term investors can exploit two enduring truths: 

• Illiquidity is mispriced – those who can lock up capital are paid to do so.
• Inefficient markets breed alpha – private markets and real assets offer opportunities that listed markets have already arbitraged away.

Swensen’s Yale Endowment holds roughly 40% of assets in alternatives, which is four times the exposure of an average institution and yet has historically achieved higher returns with lower volatility. The lesson is simple but profound: alternatives aren’t exotic extras; they are engines of structural diversification.

What the data says

The last market cycle was a live stress test. Bonds fell alongside equities, inflation surged, and the traditional 60/40 portfolio looked more like a single bet than a balanced strategy. For many investors, that period was a turning point, proof that diversification only works when its parts behave differently. 

The CFA Institute's analysis showed that introducing a 30% allocation to alternatives reshaped the entire risk-return profile. Portfolios became more efficient, with smaller drawdowns and better long-term risk-adjusted returns. 

At Yale, Swensen's experience echoed the data. By combining private equity, venture capital, and real assets (roughly 40% of total assets), the endowment produced stronger, smoother returns. The right kind of complexity, it turned out, could simplify the investment journey. 

Cambridge Associates has validated that pattern over decades of data. Their research shows that private investment funds typically take 6–8 years to “settle” into their final quartile ranking, and that 85% of funds traverse three or four different quartiles during their lifecycle before converging. For patient investors, the payoff comes from staying in the race long enough. 

Vanguard adds another layer to the story: inflation protection. Its paper, Commodity Investing and Its Role in a Portfolio, found that commodities, long dismissed as volatile, may be one of the few reliable inflation hedges left. Over 40 years, commodities showed a 0.27 correlation with equities and -0.07 with bonds, with an inflation beta as high as 10. Even small allocations can strengthen resilience when inflation strikes. 

For investors seeking diversification without illiquidity, AQR's Understanding Alternative Risk Premia points to systematic factors such as value, momentum, carry, and trend. These strategies have near-zero correlation with traditional 60/40 portfolios, offering the same low-beta independence that endowments prize, but in liquid form. 

Across Yale's endowment, Cambridge's databases, Vanguard's inflation research, and AQR's risk-premia studies, the conclusion is consistent: 

When portfolios introduce new sources of return that don't move with equities and bonds, portfolios become stronger, not riskier. 

How much is enough?

There is no universal formula, but global best practice offers a guide. 

The first 5-10% often delivers the biggest diversification benefit. Beyond that, marginal gains flatten while complexity, liquidity risk, and governance demands rise. 

This breakdown is intended as a broad guide only and reflects general research findings. It does not take into account individual financial objectives, constraints or regulatory considerations, and should not be interpreted as financial advice. Investors should seek personalised guidance before determining an allocation to alternatives.

Patience and discipline

The payoff from alternatives comes not from owning them, but from managing them with discipline and patience.

• Liquidity mapping: Model capital calls and redemption scenarios.
• Valuation discipline: Maintain independent, frequent pricing. 
• Fee control: Avoid stacked management and performance layers that erode the illiquidity premium. 
• Benchmarking: Use public-market-equivalent (PME) metrics and strategy-matched indices.
• Patience: Most private funds "zigzag across quartiles before settling," as Cambridge notes, success requires staying the course. 

The new shape of diversification

True diversification isn’t about owning more assets; it’s about owning different behaviour. Alternatives bring that difference, adding new sources of return and resilience that help portfolios absorb shocks and steady through turbulence.

The evidence is clear: portfolios built with genuine diversity of risk perform better through cycles. Alternatives can lift returns, temper volatility, and restore balance when traditional assets move together.

They’re not a niche or a novelty; they’re the next evolution of diversification. Managed with patience and discipline, they don’t just enhance returns; they reshape how portfolios behave.