At This Critical Point, Choose Your Own Portfolio Construction Adventure

Meanwhile, when public markets returned between -5% and 5%, all private equity funds outperformed the public index by 6.5% to 8.2%!

Many investors may choose to outpace inflation as well as returns of traditional asset classes by incorporating return-enhancing alternatives into their portfolios. If current valuations are a concern, perhaps choice #2 is more attractive…

Choice #2: Hunker down and manage volatility.

Since the beginning of the last bull market a decade ago, hedge strategies have struggled to achieve market returns. But with a 60/40 equity/fixed income asset allocation strategy and duration-sensitive bonds losing nearly 10% in the first quarter of 2022, advisors may be seeking alternatives.

Within this choice, there are number of options that haven’t been as attractive in recent years as they are today. Advisors may choose to look at the hedged strategy space for the first time in years. Strategies like market neutral or long-short equity are also options, aiming to isolate factors that are not correlated to inflation or rising interest rates.

Turning to private markets once again, private credit is a space that many investors find comfortable. While investments can range in credit quality, it’s possible to find senior secured investments. Often, these have underlying notes that are variable in nature and carry inherit protection against interest rate increases.

Advisors must understand the nuances of these investments, such as underlying leverage and where an investment stands in the capital stack. Being over-leveraged or allocated too heavily to subordinate debt could lead to exposure with undesired idiosyncratic risk characteristics.

Unlike in the Choose Your Own Adventure books, advisors and clients also can choose to blend several strategies to take an objective/risk replacement approach, especially if they’re underweighted to alternatives. As we head into this new adventure of weaker bonds and equities, more diversification could be your best path to choose.

Josh Vail, CAIA, is managing director of Hamilton Lane.