Targeting Resilient Portfolio Construction With Alternatives

Key points

  • As investors face continued macroeconomic and market uncertainty, evolving the 60/40 portfolio of stocks and bonds to include alternative investments may help build portfolio resiliency.
  • When selecting alternative investments, investors may want to consider strategies that seek to deliver differentiated portfolio outcomes—like amplifying returns or diversifying risk exposures.
  • The complementary risk and liquidity characteristics of liquid alternatives and private assets may make for a balanced and outcome-oriented alternatives allocation.1

The expected comeback of the 60/40 portfolio in the first half of 2023 has taken a pause as stock and bond returns face the pressure of higher yields—a backdrop reminiscent of the historic 60/40 drawdown of 2022. Despite a rising expectation for an economic soft-landing scenario, the range of potential economic outcomes remains broad and highly uncertain. Near-term recession risks have decreased, and expectations for recession have been pushed out into 2024. But the increasingly two-sided risks to a US Federal Reserve (“Fed”) committed to keeping monetary policy tight until price stability is fully restored have become more evident.

What does this backdrop mean for the durability of the 60/40 portfolio as we look ahead? Continued macroeconomic uncertainty threatens to put pressure on asset price returns. For portfolio construction, we see this as the stock and bond return correlation has again turned significantly positive in the second half of the year, with the surge in long-term bond yields driving stock and bond returns lower. This underscores the importance of building resiliency with alternative investments that offer additional sources of diversification and potential return in portfolios.

By (1) identifying strategies that seek to deliver differentiated portfolio outcomes like alpha, or excess returns that are uncorrelated to stock and bond returns, and (2) choosing a combination of strategies that are complementary and tailored to their specific risk, return, and liquidity needs, investors can seek to build an additive and effective allocation to alternatives. In this article, we discuss a framework for screening alternatives and key considerations for constructing an alternatives allocation using strategies across the full spectrum of alternatives ranging from private equity, private credit and liquid alternatives.2

Screening for alternatives that target differentiated portfolio outcomes

When it comes to selecting alternative investments, there is a wide range of strategies to choose from. The following framework breaks alternatives down into four distinct categories based on the outcomes that they’re designed to provide: hedge, diversify, modify, and amplify.

Hedge, Diversify, Modify, Amplify