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Portfolio > Alternative Investments > Private Equity

5 Ways to Diversify a 60-40 Portfolio

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What You Need to Know

  • Amid a volatile environment marked by expensive equity valuations, higher interest rates, tight credit spread, and geopolitical concerns, alternatives may help portfolio performance.
  • Private equity is one option as companies often experience their best growth periods before they go public.
  • Other tools to consider are private credit, hedge funds, real estate and structured products.

Strong equity market performance over the past decade made it easy for investors to remain locked into their traditional 60-40 portfolios, which delivered over 11% annually between 2011 and 2021.

Today, however, amid a volatile environment marked by expensive equity valuations, higher interest rates, tight credit spreads, and geopolitical concerns, investors allocated exclusively to traditional assets may be facing a bleak scenario: a potential breakdown in the negative correlation between stocks and bonds that would call into question the validity of the classic 60-40 portfolio.

Whether the stock/bond relationship has cyclically shifted or structurally changed remains to be seen. In the meantime, advisors are increasingly looking outside of traditional assets to find diversification and growth opportunities for clients.

Increasing Private Equity Allocations

Advisors working with high-net-worth investors are well versed in the potential growth and diversification benefits of allocating to private market strategies like private equity.

A long-term shift in market dynamics means there are fewer listed companies today versus 25 years ago, while surging private equity fundraising and deal activity has enabled private companies to remain private longer than in the past.

As a result, companies often experience their best growth periods before they go public, with the benefits of that growth accruing to private rather than public market investors.

Against this backdrop, high-net-worth investors are increasing their private market allocations, which are expected to top $1.5 trillion by 2025. The growing availability of private market strategies through fund structures designed for use by individual investors is helping to support this trend.

In fact, ’40 Act registered funds, such as interval and tender offer funds, enable accredited investors with $1 million or more in assets or $200,000 in annual income ($300,000 with a spouse) to access private market strategies with investment minimums as low as $25,000.

In general, these investor-friendly structures do not utilize capital calls, issue 1099s instead of K-1s (substantially simplifying tax reporting) and often offer regular liquidity opportunities.

Other Alternative Investment Tools

In addition to private equity, other alternative investment strategies may prove effective in today’s higher volatility environment, warranting attention from advisors and investors seeking to diversify their 60-40 allocations.

As with private equity, these strategies are becoming increasingly accessible to individual investors through registered funds and, in the case of structured products, separately managed accounts.

Private credit: Private credit — and in particular, senior-secured direct and asset-based lending — provides exposure to floating-rate securities, with stable total returns, attractive yields, and defensive attributes to help protect against defaults.

Additionally, private debt can provide diversification benefits, offering further value in client portfolios.

Hedge fund strategies: Multi-strategy, long-short credit and relative-value arbitrage strategies can benefit from the non-correlated, return-generating opportunities that arise in an environment of greater uncertainty and rising volatility.

Real estate: Investments in private real estate, timber, farmland and global commodities can offer compelling yields, diversification, and exposure to potential “long volatility” strategies, complementing the traditional long-only portfolio construct.

Structured products: Yield enhancement instruments allow investors to benefit from rangebound markets by combining conditional downside protection to a pre-set barrier level, along with partial upside participation via a fixed coupon that typically offers a higher yield than the standard interest rate market.

Advisors concerned that the shift in stock-bond correlations may reflect a new market reality — particularly in the context of a volatile macroeconomic environment and heightened geopolitical risks — are increasingly looking to alternatives to augment portfolio diversification and growth.

Adoption of these strategies is likely to grow along with the number of fund structures tailored to the needs of individual investors, with implications for the classic 60-40 portfolio construct.

Robert Worthington is a Managing Director and Head of Independent Wealth Solutions at iCapital. Prior to joining the firm, he held senior positions at Brookfield Asset Management, Hatteras Funds, JPMorgan Asset Management and Undiscovered Managers. He obtained a BA from the University of Wisconsin-Madison, an MBA from the University of Pittsburgh. He holds FINRA Series 7, 24, and 63 licenses.


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