How alternatives can address your 60/40 portfolio blues
Individual investors have long been told that a diversified portfolio of public equities and bonds is the key to a successful retirement plan. While that held true for a long time—especially in the past 14 years when expansionary monetary policy compressed the cost of capital and bolstered publicly traded risky assets—the mantra is now being challenged, as a number of secular shifts, including the end of the US monetary printing press that started in 2008, have the potential to render this public-oriented strategy less effective and possibly more risky.
A declining number of publicly traded companies, increased concentration of risk, rising correlations, stiff competition, and scarcity of opportunities for excess returns have all coalesced to diminish the opportunity set for investors in public markets. What’s an investor to do? As private markets continue to grow, we believe that investors should rethink their strategic asset allocation frameworks to add or increase the use of alternatives in their portfolios to curb volatility and seek to enhance potential risk-adjusted returns.
We define “alternatives” as simply an alternative to publicly traded stocks and bonds that seeks excess returns per unit of risk at every point along the risk-reward spectrum, from investment-grade credit to equity. Seen through that prism, we believe that it becomes clear that investors can explore the risk spectrum in private markets similarly to public markets. A key differentiating element is liquidity. We believe that investors who can forgo some level of liquidity stand to benefit from the opportunity in alternatives.
We believe that such a balanced, foundational exposure to alternatives can, in our view, be deployed as the core component of an alternatives sleeve of a portfolio—which can over time be supplemented by niche exposures (i.e., venture, impact, among others)—or alongside public beta as a core equity replacement. Further, we believe that investors should differentiate between asset allocation and manager selection when adding alternatives to a portfolio, for two main reasons: 1) dispersion of returns is not uniform in the alternative space, with some asset classes, such as private equity, exhibiting higher levels of dispersion, while others, such as private credit, a little less so; and 2) the size and scale of the asset manager matter a lot for a variety of reasons, from ability to source and seize opportunities to providing liquidity to governance factors. In short, picking the right partner is key.
The end of the unprecedented monetary expansion experienced in the past 14 years has fundamentally changed how individuals should invest for retirement. We believe that the scarcity of excess returns in public markets will continue to pressure investors to look for alternative sources of potential alpha. Concurrently, we believe that the “democratization of finance” has prompted investors to reevaluate their traditional allocations, opening a window of opportunity for them to participate in—and benefit from—the long-term trends developing in the alternatives space.
To learn more, read our white paper.