The case for adding alternatives to a traditional 60/40 portfolio

As Exhibit 1 shows, an investment of $1 million in the third quarter of 2007 would have returned nearly $2.3 million with a 20 per cent allocation to alts, over $340,000 more than a classic 60/40 approach. It is noteworthy that the model alts allocation on its own would have returned more than $4.1 million – double the return from the traditional portfolio. Put another way, adding alts to a 60/40 portfolio increased the total return by nearly 20 per cent, translating to an annualised returns increase of more than a percentage point. While history does not necessarily repeat itself, the increased returns of the model portfolio with alternative investments tells a powerful story.

Simulated performance provides another lens with which to analyse the impact of alternative investments on a traditional 60/40 portfolio in a wide range of market environments. Using a Monte Carlo simulation, our analysis found that the model portfolio with alternative investments outperformed the traditional 60/40 portfolio in all but 128 out of 10,000 runs – that is, 98.7 per cent of the time (see Exhibit 2). The model portfolio with alternative investments would have cumulatively produced 8.5 per cent higher returns after 60 quarters at the top decile level, 17.1 per cent higher returns at the median level and 25.8 per cent higher returns at the bottom decile level. While the inclusion of alts was beneficial to a 60/40 portfolio across the board, the greater outperformance at the lower end of the outcome range highlights the protection alts can offer in more difficult environments.