Why alternatives are no longer alternative

Portfolio construction and asset allocation are the bedrock of investing, and for decades, the classic 60/40 split has been the tried and true strategy. But in today’s volatile macro environment, its effectiveness is under scrutiny. Investors are left wondering: where should their money be invested, and at what weight should their holdings be allocated?

Alternatives seem to be having their moment in the sun. Once seen as niche, they’re now increasingly part of the conversation. But is this simply a passing phase, or does it reflect a more profound structural shift?

Encompassing private equity, private credit, infrastructure, real assets, and Hedge Funds; alternatives offer access to return streams beyond listed markets. They provide exposure to opportunities that move to a different beat, opening the door to assets and companies otherwise out of reach for most investors.

To unpack where the most compelling opportunities lie, we spoke with Alexandre Ventelon of Morgan Stanley. He shares why his conviction in alternatives goes beyond a passing trend, and why, in his view, they represent the “new normal” for portfolio construction.

The latest Morgan Stanley asset allocation shows Alternatives as your most overweight asset class – what’s the appeal right now, especially compared to stocks and bonds?

In the current macro environment, we consider alternatives as appropriate for a higher allocation in multi-asset portfolios due to their potential to address dispersion, dislocation, and duration risk. Equity markets currently display increased bifurcation, with performance concentrated in several large-cap companies, while broader market valuations appear stretched and volatile. Amid elevated volatility, policy uncertainty, and high valuations in traditional assets, alternatives offer a favourable risk-return profile. This approach represents a strategic adjustment towards exposures that are less correlated with public markets and may be more resistant to cyclical changes. Alternatives provide opportunities for capital growth during market disruptions, especially in private markets where inefficiencies and pricing lags might create potential for additional returns.

Morgan Stanley talks to ongoing market dislocation and volatility as the reasons – can you be more specific as to what you’re trying to avoid and how alts can help you do so?

We aim to mitigate exposure to duration risk, equity beta, and liquidity-driven drawdowns. Alternatives, especially private equity, private credit, and hedge fund strategies, offer some insulation from mark-to-market volatility and enable us to ‘side-step’ forced selling during stress events. They also allow us to express views on secular themes (e.g., energy transition, digitisation) without relying on public market sentiment.

Private debt and private equity are noted as preferred exposures – can you share some of the characteristics you are looking for within these buckets and the types of managers you are prioritising?

Manager selection in Alternatives is essential, as this is the asset class where there is the most dispersion between top and bottom performers. In private debt, we prioritise senior-secured, floating-rate structures with strong covenants and low default risk. Asset-based lending is particularly attractive in this environment, offering collateral-backed yield with downside protection. In private equity, we favour managers who are established players with operational expertise, sector specialisation, strong deal access and disciplined underwriting. We seek those managers who can drive value creation through active ownership and have demonstrated resilience across cycles.

Alternatives is a big bucket – is there anything else that you’re liking in the space?

Beyond private debt and private equity, we are constructive on:

1. Hedge funds in general, as elevated interest rate environments has historically served as a tailwind to hedge fund performance. More specifically, we like Long/Short and Active Extension Strategies: These offer asymmetric return profiles and allow us to express high-conviction views while managing downside risk. They are particularly effective in volatile, range-bound markets.
2. Infrastructure offers inflation-linked cash flows and long-duration assets with a stable yield. We favour digital infrastructure and energy transition assets.
3. Private equity secondaries provide access to seasoned portfolios at discounts, mitigating the J-curve and enhancing internal rate of return potential.
4. Opportunistic credit allows us to capitalise on dislocations in credit markets, especially in stressed sectors.

How does an exposure to alternatives help diversify risks and improve returns?

Alternatives reduce portfolio volatility and improve Sharpe ratios by ‘tapping into’ idiosyncratic drivers. They offer structural advantages - such as lower correlation, reduced drawdowns, and thematic exposure - that are difficult to replicate in public markets. Our Capital Market Assumptions and optimisation work show that portfolios with a meaningful allocation to alternatives exhibit better downside protection and more consistent return profiles.

There have been some concerns around transparency and asset valuations in private markets. How do you protect against these risks?

We mitigate these risks through rigorous manager selection, favour standalone valuation processes, and robust governance frameworks. We prefer managers with clear reporting standards, third-party oversight, and transparent fund structures, as they tend to be higher in Alternatives and their impact on net returns is greater (versus long-only). Evergreen vehicles and interval funds also help streamline administration and reduce opacity in capital calls and distributions.

Under what conditions would you likely shift away from your overweight in alts, or is this a new normal given the benefits they offer?

Our conviction in alternatives is structural. The asset class’s ability to deliver uncorrelated returns, absorb liquidity shocks, and compound capital through cycles makes it a cornerstone of our strategic allocation. We view this as a ‘new normal’ rather than a temporary tilt, especially as traditional asset classes face persistent headwinds.

While the current overweight is strategic, a shift away could be warranted under the following conditions:

1. Normalisation of Public Market Valuations: If equity and bond markets reprice to more attractive levels with improved risk-adjusted returns, the relative appeal of alternatives may diminish.
2. Liquidity Constraints or Regulatory Changes: A tightening in liquidity conditions or regulatory shifts that impact private market structures could reduce the flexibility and attractiveness of alternatives.
3. Compression of Alpha Opportunities: If private markets become overly crowded or pricing inefficiencies narrow, the alpha potential may erode, prompting a reallocation.
4. Improved Transparency and Pricing in Public Markets: If public markets evolve to offer better thematic access, lower volatility, or more innovative structures, they could reclaim some of the roles alternatives currently play.

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