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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 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.

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 business cycles?

Allocations vary, but a strategic exposure of 20-40% to alternatives is a level some investors may consider, depending on their objectives and risk tolerance.

Some investors may choose to implement this through a core-satellite structure, combining broadly diversified strategies with select, higher-conviction opportunities.

Use a core-satellite structure:

• Core: Multi-manager platforms or diversified funds of funds for stability.
• Satellite: High-conviction single-strategy funds for opportunistic exposure.

Stay committed for the long term

Private markets require careful pacing. Capital is often deployed gradually, and distributions may occur years later. Without continued reinvestment, exposure can decline. A long-term capital plan may help mitigate vintage concentration and maintain consistent exposure.

Hedge fund allocations, in contrast, may offer more liquidity and flexibility. Some investors adjust allocations tactically – scaling exposures to directional or diversifying strategies based on changing macro conditions.

For private markets, commitment pacing is crucial:

• Capital is deployed gradually (over 3-5 years).
• Distributions return capital later – so without reinvestment, exposure declines.
• A programmatic commitment cycle supports consistent compounding and helps mitigate vintage risk.

In contrast, hedge funds can play a more dynamic role:

• Tactically adjust their positions to capitalize on changing market conditions. Rebalance into or out of directional strategies depending on macro trends.
• Maintain consistent exposure to diversifiers for structural portfolio support.

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

Diversification with downside mitigation

Certain hedge fund strategies are designed to perform independently of market direction. Strategies such as equity market neutral, merger arbitrage, 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, would have reduced volatility from 9.2% to 8.5%, and increased annualized returns from 5.7% to 5.9% over the period from 1997 to 2024 (ÃÛ¶¹ÊÓƵ, HFRI, 1997-2024).²

² Hypothetical performance based on back tested index data from 1997-2024. Not actual results. Does not account for trading costs or investor behavior. Past performance is not indicative of future results.

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)

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 and have shown the potential to be effective complements to bonds or equities.
• Substitutes (e.g. equity hedge, convertible arbitrage) offer targeted exposure and have historically demonstrated more favourable risk-return dynamics compared to traditional asset classes.

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

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, we believe the core principles – diversification, discipline, and manager selection – are broadly applicable. They can 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.

• In a multi-asset portfolio, these features are especially attractive, as they can dampen losses in a bear market, improve diversification, and preserve capital.
• An investor who held a balanced portfolio of 50% equities and 50% bonds over the past 27 years could have increased annualized returns from 5.7% to 5.9%, while reducing volatility from 9.2% to 8.5% by moving 20% of their traditional asset class allocation to hedge funds.
• During the global financial crisis, holding a 20% allocation to hedge funds in a balanced equity/bond portfolio could have lowered maximum loss from -31.2% to -29.3% (see Table 1).