Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The US equity market, represented by the S&P 500 index, rose 1.7% for the week ending May 19.
  • Risk-reducing alternative strategies can provide diversification to “traditional” asset classes, but large allocations to alternatives come at the expense of allocations to stocks and bonds – which remain important drivers of long-term returns. 

In the aftermath of the Great Financial Crisis of 2008, virtually every investor began to reassess their stock market exposure. A portfolio of global stocks was off over 50% from peak-to-trough during the crisis, and a balanced portfolio of 60% stocks and 40% bonds was down over 30%.

Advisors and consultants flocked to alternatives as they wanted to show their clients that they were doing something about portfolio volatility. These strategies, which include equity and credit long/short, market neutral, global macro, and managed futures, provided a good story for consultants and asset managers to tell.

Post-GFC, it became vogue to introduce large allocations of risk-reducing alternatives to balanced portfolios. “New” balanced portfolios had allocations of 20% or 30% in alternatives.

The rub is that some other part of the portfolio had to be reduced to accommodate those chunky new alternatives allocations. After 2008, it was the equities allocation that was most typically in the crosshairs. “New” balanced portfolios were often in the range of 40% stocks, 40% bonds, and 20% in alternatives.

In hindsight, this reallocation from stocks to alternatives was akin to selling equities at the market bottom. Stock market returns were strong for the next decade.

Now, some are proclaiming once again the “death” of the 60/40 portfolio and the need to re-evaluate allocations to “traditional” asset classes. In 2022, stocks and bonds struggled mightily as the Federal Reserve embarked on its interest rate hiking campaign to squelch inflation.

In a Pensions & Investments magazine article this week, the CEO of a large consultant/advisor noted that “50/30/20” might serve as a new asset allocation model for portfolios, with the 20% referring to “high quality alternatives” which refer to investments in "more mature markets that are less speculative and typically exhibit more stable volatility, consistent diversification benefits."

Reducing fixed income allocations now that interest rates have risen feels very similar to the post-GFC approach of reducing equity allocations after the market had plummeted. The return profile for bonds has not looked so attractive in years. Now is most likely not the time to trim bonds in portfolios.

There is an aura around alternative strategies, rooted in the well-publicized success of hedge fund managers such as Jim Simons at Renaissance Technologies as well as the approach of many prestigious university endowments. As of June of last year, Princeton University had about 75% of its $35 billion endowment in alternatives. The University of Michigan had over 80% of its endowment there.

For the vast majority of individual investors or for smaller nonprofit endowments, these types of allocations make no sense. Apart from the fact that university endowments have access to managers that most individuals do not (and know how to conduct manager due diligence to find them), private alternatives are less liquid, less transparent, and far more expensive than exposure to “traditional” asset classes. To boot, it is often difficult to figure out what returns are due to the timing of cash flows, which can be frustrating.

Individuals and nonprofits with smaller cash pools are best served with thoughtful allocations to stocks and bonds. Risk-reducing alternatives can be deployed to take the edge off equity market volatility or to mitigate interest rate risk, but for long-term portfolio returns, traditional asset classes will remain in vogue.


IMPORTANT DISCLOSURES: All info contained herein is solely for general informational purposes. It does not take into account all the circumstances of each investor and is not to be construed as legal, accounting, investment, or other professional advice. The author(s) and publisher, accordingly, assume no liability whatsoever in connection with the use of this material or action taken in reliance thereon. All reasonable efforts have been made to ensure this material is correct at the time of publication.  Copyright Indiana Trust Wealth Management 2023.