Chris Loeffler is the CEO of Caliber (CaliberCos Inc.), an alternative asset manager and fund sponsor with approximately $500 million in assets under management.
The investment landscape is changing, and it was before seismic volatility shook the portfolios of most individual investors in 2022. Today, the headwinds for the traditional portfolio of 60% public equities and 40% fixed income continue to build. These are fueled in part by a better understanding of and access to alternative investment options. But I think it’s important for investors to understand the secular shifts that are challenging conventional asset allocation paradigms.
Old Faithful: The 60/40 Portfolio
Since the early 1980s, the 60/40 portfolio of public stocks and bonds has been the gold standard for achieving long-term wealth. The simple mixed portfolio is based on the principles of modern portfolio theory and is designed to deliver attractive, risk-adjusted returns with less annualized volatility. Today I see this familiar portfolio framework take on challenges of major market shifts.
An evolving investment landscape
Several factors have fundamentally changed the investment landscape in the US. While some of these stem from underlying market conditions that may be more transient than systemic, others are shifts in market opportunities, such as a quantifiable increase or decrease in the type of investment opportunities available.
For example, within public markets, investors have generally embraced passive funds, which are designed to track the performance of a market index. These funds provide a straightforward vehicle for diversifying one’s investments with relatively low to very low fees. At the end of 2021, total net assets in index mutual funds and index ETFs were $12.5 trillion, accounting for 43% of assets in long-term funds.
Interestingly, while the inflow of passive investing grew steadily, the number of listed companies suddenly dropped. The number of publicly traded companies in the US peaked in the mid-1990s with over 8,000 companies. In 2019, that number decreased by almost 50% to 4,266, leaving investors with far fewer individual stock options for their portfolios. Individual investors face diminishing opportunities in public markets, which are more crowded, concentrated and correlated.
These numbers are consistent with the well-reported explosion of private market capital. More companies are turning to private markets for the capital they need to grow and expand their businesses. In fact, more capital was raised in private markets every year for more than a decade between 2009 and 2019 than in public markets. As a result, private markets have played an increasingly important role in driving innovation, value creation and economic growth across all sectors.
Reshape asset allocation frameworks
Today, I’ve seen many investors explore the potential benefits of redesigning their asset allocation frameworks to add or increase exposure to alternative assets – and with good reason.
Adding alternatives to a traditional portfolio can reduce volatility and improve potential risk-adjusted returns. When JP Morgan checked the numbers, they found that adding a basket of alternative assets to a baseline 60/40 portfolio helped manage risk and improve returns. Shift from a 60/40 portfolio to 30% alternative investments, 40% equities and 30% fixed income increased returns year-over-year from 8.39% to 9.04% and reduced volatility from 9.66% to 7.97% over the period under review.
Challenges to access
According to PwC, “Alternative asset classes – notably real assets, private equity and private debt – will more than twice as bigto $21.1 trillion by 2025, accounting for 15% of global assets under management.”
Unfortunately, access to these alternatives is still largely an exclusive club. Most investment strategies are designed for large institutional investors and insiders. This leaves the vast majority of individual investors without sufficient exposure or opportunity to participate. Even when the opportunity arises, they are usually ‘private’ shares of a fund, with fee structures generally less favorable than those for institutions. Still, these investments hold the potential for high capital gains compared to typical retail opportunities.
If the status quo continues, I think small investors risk falling further behind in wealth generation.
Building modern, well-rounded portfolios
There are promising signs on the horizon and an increasing number of alternative asset managers in the market are breaking through the barriers of exclusive investing. There’s a lot more work to be done, but I think we’re moving in the right direction to change the access equation.
I recommend that individual investors work with their advisors to determine how their portfolios can benefit from the inclusion of alternative investments across various asset classes and industries, including private equity, direct lending, hedge funds, infrastructure and real estate. Since it concerns private real estate investments, my areas of expertise, many advisors recommend a 10% allocation. Of course, the correct number will be higher or lower depending on your goals, objectives and risk tolerance.
Increasing your awareness and education about the availability of alternative asset investments is a critical first step in future-proofing your portfolio and achieving your financial goals.
The information provided here is not investment, tax or financial advice. You should consult a licensed professional for advice on your specific situation.