ÃÛ¶¹ÊÓƵ

Alternatives are not a monolith – they include a diverse spectrum of investment types that may behave differently from traditional asset classes. Each type can serve a distinct role:

• Private equity targets high-growth companies, often inaccessible through public markets.
• Private credit may offer stable income through direct lending and bespoke financing.
• Real assets like infrastructure and real estate, can act as a hedge against inflation and contribute to portfolio diversification.
• Hedge funds, long overlooked by private investors, might offer both diversification and liquid flexibility – particularly in volatile or uncertain markets.

While private equity and credit typically require long-term capital commitments, hedge funds can offer more liquid exposure and may respond more dynamically to changing market environments. A carefully constructed allocation across these segments could support improved portfolio resilience over time.

1. Define your strategy

Constructing an alternatives portfolio begins with clear intent:

• Return focus: Seeking growth, income, or absolute returns?
• Risk appetite: How much volatility and drawdown can you withstand?
• Liquidity profile: Are you prepared for illiquid investments – or do you need tactical flexibility?
• Time horizon: Are you thinking in decades or in business cycles?

Allocations vary from investor to investor, and highly depend on personal objectives, appetite for risk and tolerance for illiquidity. As a general rule, holding up to 20% of a liquid portfolio in alternative should enable investors to avoid running short of cash, including in periods of market stress. This allocation may rise up to 40% if an investor have modest cash flow needs from their portfolio and can draw on liquidity from another source.

2. Combine illiquid and liquid alternatives thoughtfully

A diversified portfolio may benefit from a blend of long-term strategies and shorter-term flexibility:

In today’s market environment – characterized by shifting macro regimes and stretched valuations – hedge funds may offer several potential benefits to an alternatives portfolio:

1. Diversification with downside protection

Certain hedge fund strategies are designed to perform independently of market direction. Strategies such as equity market neutral, multi-strategy, and macro trading have demonstrated the ability to reduce portfolio drawdowns during market sell-offs. Historical analysis shows that incorporating hedge funds into a traditional portfolio not only smooths performance but accelerates recovery from drawdowns.

Example: In one illustrative scenario, a 20% hedge fund allocation in a 60:40 portfolio, sourced equally from equities and bonds, historically reduced volatility from 9.2% to 8.5%, and improved annualized returns from 5.7% to 5.9% (ÃÛ¶¹ÊÓƵ, HFRI, 1997-2024).

2. Flexible exposure in shifting markets

Hedge funds are unconstrained vehicles with access to tools beyond the reach of most long-only managers. This includes short positions, derivatives, and structured instruments. That flexibility enables them to capture opportunities and mitigate risk across asset classes, regardless of market direction.

Styles like:

• relative value (exploiting pricing inefficiencies);
• macro (positioning across global themes);
• event-driven (capitalizing on corporate actions);
• equity hedge (long/short equity strategies).

3. Substitute or complement? Both.

Depending on the strategy, hedge funds may act as a complement to or a substitute for traditional assets.

• Diversifiers (e.g. systematic CTAs, macro multi-strategy) act as low-correlation stabilizers – ideal bond or equity complements.
• Substitutes (e.g. equity hedge, convertible arbitrage) offer targeted exposure with better risk-return dynamics than traditional asset classes.

Hedge funds have historically shown upside participation during up markets, while helping to protect capital in drawdowns – a combination that may support more stable long-term return compounding.

Large endowments and institutions have played a pioneering role in allocating to alternatives. Yale and Harvard paved the path decades ago:

• holding 30-50% of assets in alternatives;
• diversifying across vintages, managers, and geographies;
• using hedge funds not just to generate alpha – but to reduce portfolio fragility. While private investors may not fully replicate this model, the core principles – diversification, discipline, and manager selection – are broadly applicable. They adopt similar principles using structured programs, evergreen funds, and guided solutions, depending on their individual circumstances.
  

Alternative investments offer attractive long-term benefits – but they also come with distinct risks:

• Illiquidity: Many alternative strategies, particularly private equity and credit, require long lock-up periods.
• Leverage: Some hedge fund and credit strategies use borrowing to enhance returns, which increases downside risk.
• Transparency: Information on fund holdings and strategy shifts may be limited.
• Operational complexity: Manager selection, risk oversight, and governance structures vary widely.
• Performance dispersion: Within each style, outcomes can differ significantly by manager. Indices are not directly investable and may not reflect actual portfolio performance.