The traditional 60/40 portfolio is facing new challenges in a world of persistent inflation and shifting market dynamics. In this article, Keyridge Asset Management explores how alternative assets can enhance diversification and provide investors with additional sources of return beyond equities and bonds.
For decades, investors have relied on a mix of equities and bonds to deliver growth and diversification.
The traditional 60/40 portfolio worked particularly well during a period of falling inflation, declining interest rates and a largely negative correlation between stocks and bonds.
However, the market environment has changed, and with it long-held assumptions about diversification.
As investors search for additional sources of return and resilience, alternative assets are increasingly moving from the periphery of portfolio construction to acting as a third pillar.
What are alternatives?
At their simplest, alternatives are investments and strategies that sit outside traditional long-only equities, bonds and cash.
Alternative assets include real assets such as infrastructure and property, private markets such as private equity and private credit, commodities such as gold, and specialist strategies including managed futures, global macro, market neutral and insurance-linked securities.
Perhaps the most important contribution alternatives make is genuine diversification. Modern equity markets are becoming increasingly concentrated, with global indices now dominated by a relatively small number of large US technology companies.
Alternatives introduce different return drivers, creating opportunities for portfolios to perform in a wider range of market environments. These independent return drivers mean alternatives can often exhibit low correlation to both equities and bonds.
Another advantage of alternatives is their potential to provide protection against inflation. Many alternative assets are directly linked to the underlying drivers of inflation.
Historically, many investors relied on bonds to fulfil this role. But as inflation and interest-rate shocks have shown, bonds do not always provide the protection they once did.
This is increasingly relevant given the structural forces currently shaping markets. Deglobalisation, geopolitical tensions, supply chain disruption, fiscal expansion and energy transition spending are all contributing to a world in which inflation may be more persistent and volatile than investors have been accustomed to.
Importantly, alternative investing is no longer reserved for large institutions. The growth of UCITS funds, ETFs, investment trusts and Long-Term Asset Funds (LTAFs) has broadened access.
Retail investors can now gain exposure to strategies such as managed futures, gold, infrastructure, specialist credit and market-neutral investing through regulated, transparent investment vehicles with relatively low minimum investments.
Different assets, different roles
While alternatives share common characteristics, many can serve distinct purposes within a portfolio. Although no single alternative asset works in every market environment, used together, they can strengthen overall portfolio diversification.
1. Carry
The carry strategy can play an important role within a diversified portfolio by providing a source of yield beyond traditional fixed income assets.
These alternative assets generate predictable income streams from loan interest, rental income, lease payments or insurance premiums. Examples include private credit, infrastructure assets, renewable energy projects, property income and specialist asset leasing.
These income streams often arise because investors are being compensated for accepting factors such as complexity, reduced liquidity or the need for specialist expertise.
However, some carry assets may remain sensitive to economic conditions and periods of market stress. As a result, they are often most effective when combined with other return drivers within a broader, diversified investment framework designed to balance income generation, growth potential and portfolio resilience over time.
2. Protection
The second element is protection. Some alternative asset strategies are designed to benefit from major market dislocations, sustained trends or increases in volatility.
Examples include trend-following and managed futures strategies, defensive global macro funds, long-volatility approaches and gold.
These assets may lag during strong bull markets and can appear frustrating when markets are rising steadily. However, they often show their worth during periods when traditional assets struggle simultaneously.
These are the types of assets that have historically delivered value in environments where the traditional 60/40 portfolio has come under pressure, including periods such as 2008 and 2022.
3. Uncorrelated returns
The third component is sources of return that are largely independent of broader market movements, often deriving their value from completely different events and risk drivers.
One example is catastrophe bonds, which are influenced by weather-related events, while litigation finance returns rest on the outcome of court judgements.
Another example is market-neutral strategies, which aim to profit from relative mispricing while removing broad market exposure altogether.
The trade-off is that these opportunities are often more complex, capacity-constrained and typically more expensive to access. Manager skill and careful due diligence can therefore play a critical role in determining outcomes.
Looking Beyond 60/40
The rise of alternatives does not mean that equities and bonds have lost their place in portfolio construction. Rather, it reflects a growing recognition that diversification requires more than simply owning two asset classes.
Alternatives offer a wider toolkit, providing uncorrelated returns, inflation resilience, enhanced income opportunities and access to genuinely diversified sources of risk and return.
The value of investments may fall as well as rise and investors may not get back the amount invested.
The information contained in this document is provided for use by professional advisers and is not for onward distribution to, or to be relied upon by, retail investors.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. This document is issued for information only by Keyridge Asset Management.
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