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Allocating more to alternative assets could help bolster portfolio performance as bond and stock prices fall together.

A key tenet of the 60/40 model of portfolio building – allocating 60 percent to equities and 40 percent to fixed income – is that bonds and stock prices usually move in opposite directions. Equities are likely to outperform in sunnier economic climates, while bonds can provide some downside protection in gloomier conditions. This has served investors well for years; between 2011 and 2021, the 60/40 portfolio generated an 11.1 percent annual return.1

Recently, however, this has changed abruptly. In the first six months of 2022, the Bloomberg US 60/40 Index was down around 17 percent.2 The S&P 500 fell by 20 percent over the same period.

Historical Valuation Levels

One the surface, these falls appear to stem from previous historical valuation levels. The S&P 500 notched 70 all-time highs in 2021, for instance3, while at the start of this year, German government bonds with maturities of 10 years or longer were still offering negative yields.4 However, this ignores the fact that the traditional stock-bond relationship has been fundamentally altered by changes to the economic and monetary environment.

«High inflation, increasing interest rates and high uncertainty are destabilizing the relationship between bonds and equities,» says Pavel Ermoline, Investment Director at Moonfare. «This is weakening the impact of the 60-40 model.»

Given this context, investors have been increasingly looking toward private markets in a bid to bolster their portfolios.

The Place for Private Equity

Many of the larger institutions have been doing this for years, diversifying their pool of assets to broaden their sources of returns. Analysis by Blackstone suggests pension funds reserve roughly a quarter of their allocation to alternatives, while for endowments this figure is over half. Alternatives exposure for individual investors, however, is just 5 percent.5

«The penetration to the broader investor market has taken more time,» Ermoline says. «Challenges such as illiquidity, access and an education gap mean some are not yet in a position to extract the full potential of a PE allocation.»

Well-balanced Portfolio

Overcoming these challenges could present investors with the opportunity to access the benefits that assets such as private equity provides as part of a well-balanced portfolio. These benefits include:

  • Potential for higher risk-adjusted returns. Private equity’s track record of a long-term return profile could prove highly beneficial in an environment of lower returns from bonds and stocks. Research by Hamilton Lane shows that between 2000 and 2020, a rigid 60/40 portfolio offered annual returns of around 7.5 percent. However, a portfolio with a larger allocation to private markets (42 percent public equity, 28 percent bonds, 18 percent private equity, 12 percent private credit) offered annual returns of 9.40 percent.6
  • Greater diversification. Adding a private market allocation to a portfolio means owning a wider and more diverse section of the investment landscape. This, in turn, diversifies and spreads risk at a lower level through the portfolio, rather than concentrating it in one area. Indeed, according to Hamilton Lane research, the overall risk profile of a portfolio fell as select amounts of private credit and equity were added.

«The private equity model makes a lot of sense in a downturn, where operational support is key to weather the storm,» says Ermoline. «Many investors have already shifted their asset allocation towards including more private equity, and have demonstrated how this decision can lead to robust performance generation through multiple cycles.»

  • To read the entire article visit the Moonfare blog, where you can see other insights on how to navigate private markets.

Sources:
1 gsam.com
2 bloomberg.com
3 axios.com
4 bundesbank.de
5 blackstone.com
6 hamiltonlane.com

Important Notice: This content is for informational purposes only. Moonfare does not provide investment advice. You should not construe any information or other material provided as legal, tax, investment, financial, or other advice. If you are unsure about anything, you should seek financial advice from an authorized advisor. Past performance is not a reliable guide to future returns. Your capital is at risk.