Diversification has long been seen as the cornerstone of sound investment strategy. But, as financial markets evolve, so must advisors’ approaches to portfolio construction. Let’s explore the changing landscape of diversification and the crucial role that alternative investments can play in building a well-rounded portfolio. We’ll dive into why the traditional 60/40 portfolio allocation may no longer be sufficient in today’s dynamic market environment.

Understanding Diversification

As you know, diversification is the practice of spreading investments across different asset classes, sectors and industries to reduce risk. While the principle remains as important as ever, the definition of what constitutes a diversified portfolio has changed over time. During every rolling three-year period between June 2009 until December 2021, traditional 60/40 portfolios had higher returns than those with more complex strategies according to Morningstar portfolio strategist Amy Arnott. Once inflation began to spike in 2022, and eventually peaked above anywhere it had been in 40 years, the Fed responded by raising interest rates at a rate that hammered bonds.

Historically, bonds served as a shock absorber in a 60/40 portfolio when stocks tanked. Although that defense mechanism broke down in 2022, thankfully it has rebounded a bit in 2023 as the U.S. Federal Reserve did not raise interest rates at the same pace as the year before. However, the traditional 60/40 allocation, with 60% in stocks and 40% in fixed income, is continuing to face challenges. 

In this unprecedented time, it makes sense to consider how to help portfolios evolve beyond tradition.

Why the 60/40 Portfolio Needs an Overhaul:

Although we touched on it above, there are three primary issues that advisors are seeking to address when they’re ready to modernize their portfolios.

Changing Market Correlations – In today’s interconnected global economy, traditional asset classes have become more correlated. Economic events that once affected only specific markets can now trigger widespread impacts. This makes the 60/40 model more vulnerable to systemic risks.

Volatility and Uncertainty – Heightened market volatility and geopolitical uncertainties have become more prevalent. As a result, relying solely on stocks and bonds may not provide adequate downside protection during turbulent times.

New Asset Classes and Investment Opportunities – The options for where you can invest your money has expanded far beyond traditional stocks and bonds. Alternative investments, such as real estate, private equity, and hedge funds, now offer investors a broader array of choices.

In The Allocators Edge, Phil Huber underscores this evolving financial terrain by stating, “As financial innovation flourishes, we continually push new boundaries both in the discovery of novel asset classes and strategies, and the unlocking and democratizing of investments to benefit more people. Technological advancements, academic insights, and the tireless efforts of industry practitioners all contribute to a future for investors that allows more opportunities to diversify, removes frictions, lowers costs, and improves access and fairness.”

Why Incorporating Alternative Investments is Key

Moving outside of the traditional options for portfolio construction isn’t a radically new idea. Most investment officers, analysts and advisors are aware of these three benefits you may receive from alternative investments. 

Enhanced Diversification – Alternative investments often have low correlation with traditional assets. This provides an additional layer of diversification that can help cushion a portfolio against market shocks that traditional investments are otherwise susceptible to.

Potential for Enhanced Returns – Many alternative investments have historically demonstrated the potential for higher returns compared to traditional assets. By incorporating these into client portfolios, advisors can seek to optimize portfolio performance.

Access to Niche Markets – Alternative investments offer exposure to unique sectors and strategies that may be less accessible in traditional markets. This allows for greater flexibility in tailoring portfolios to specific client values, goals and risk profiles.

It’s crucial to remember to stay aligned with your individual clients’ risk tolerance and preferences throughout the process of allocating investments. As you’re well aware, wealth management isn’t a one-size-fits-all approach; it’s essential to assess each client’s unique situation so that you can continue to provide them with the most effective and tailored service possible.

While alternatives open up a lot of opportunities, they also introduce complexity to the financial advisory firm. Conducting proper due diligence, keeping track of subscription documents and the process as a whole can be overwhelming. Mammoth Technology is bridging the gap between investors, financial advisors, and fund managers through an intuitive, integrated platform where diligence and data can flow to the right people at the right time. Mammoth is designed to help onboard investors, manage cap table data, facilitate tax document distribution, synthesize accounting service details, and more. 

See how Mammoth’s Integrated Alternatives Platform can help you today. Click here to schedule a call.