Where do alternatives fit in traditional portfolios?

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Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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David Wong, chief investment officer, managing director and head, Total Investment Solutions with CIBC Asset Management 

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With today’s investors up against increasing challenges in the continued search for enhanced long-term returns, downside protection and portfolio diversification, many are looking beyond the traditional 60:40 portfolio in the search for better long-term outcomes. In the first of our two-part Exploring Alternatives podcast series, I’ll be looking at the evolution of alternative investments, and the purpose they can have within a traditional portfolio. Be sure to look for part two next week, where my colleague, Meric Koksal, will be taking a deeper dive looking at asset allocation among the different classes of alternatives. 

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Alternative investing today can be loosely defined as anything that is not included in the typical traditional investment food groups of stocks, bonds and cash, which are investments that are easily accessible and liquid. 

Now to simplify and narrow the scope for a useful discussion, we might bucket alternatives into a couple of categories: alternatives where the underlying assets themselves are liquid, such as hedge funds or even commodities; and those where the underlying assets are illiquid, such as private equity, private credit, private real estate and private infrastructure. 

Now, the evolution of alternative investments goes back a long time. The first private equity funds, where institutional investors paid professional managers to buy private companies, were formed in the 1940s, focused on venture capital or early-stage growth investments. And the evolution into buyout-focused private equity, which is so popular today, really got its start in the 1970s. Now, the first hedge fund, which focused on long/short equity was formed in the 1950s. 

While these alternative investments have been around since the 1940s, the evolution of the widespread adoption of alternative assets really begins in the 1980s, with the approach that David Swensen developed when he took over as the head of the Yale endowment. When he took over the Yale fund in 1985, it was about 90% invested in traditional assets: equities and bonds. And by 2020, it had about 75% in alternative assets in a combination of private equity, hedge funds, real estate and natural resources. 

With that approach, he helped the endowment achieve annualized returns of 13.7% from 1985 until his passing in 2021, which was over 3% higher than the average for his endowment peer group, and about 5% higher than the S&P 500. 

These results have transformed how institutions and high-net-worth individuals have invested over the past several decades, and is now widely known as the Yale Model. Ultimately what these investors have learned is that trading off liquidity of public exchange-traded securities and lower risk investments, such as bonds, in exchange for lower liquidity has resulted in better returns over the past few decades. 

Today, estimates peg the amount of assets at $5 trillion in hedge funds, and $13 trillion in private assets. So it’s a very big part of the investment landscape. 

However, for individual investor portfolios, there is very little presence of these alternative investments up to this point for the simple fact that these funds are not available to most individual investors. They demand a big upfront commitment of capital in amounts that are out of reach for most investors. And an investor typically cannot simply go out and buy a fund at any time. There are fundraising periods that private managers have, and relationships and due diligence is required, which typically necessitates an investment team to do the background work before investing. 

So the excitement for the individual investor today is that these choices have increasingly become available to them over the past couple of years, with the creation of alternative funds geared towards individual investors who access their investments in wealth channels. These funds are typically built with very investor-friendly features: 

• Evergreen availability, meaning you can buy a fund when you need the allocation, rather than depending on a private asset manager’s fundraising schedule; 

• You can make the investment with a single transaction that doesn’t require unpredictable capital calls over time; 

• There are lower minimum investment sizes as well, and often, a diversified portfolio on day one; and 

• There are relatively frequent subscription and redemption periods. 

Essentially, all the things that make alternatives inaccessible to all but the most scaled institutions and family offices are eliminated with these new products geared towards wealth channel investors. From that perspective, we are living in very exciting times as far as the implications for adoption by a wider group of individual investors. 

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Now, how individual alternative assets are performing in the current macroeconomic environment is quite difficult to speak in general, just given that the performance of alternative assets have such a wide range of returns around them, and the returns really be vary based on manager selection. So it’s hard to talk about the alternative market as a single category of investing. 

Also, data availability can be more difficult than we typically see from traditional investments due to factors such as lags and appraisals for private assets, just as one example. If we look at one category of alternatives that do report the returns on a timely basis: relative value market-neutral equity hedge funds. Now the investment universe has over 125 managers in this universe, and the median manager had a positive return in the first quarter of 2025, when the S&P 500 had a negative 4.3% return in U.S. dollar terms. 

Now, it isn’t unusual to see these types of funds do better in volatile periods, given that they take on very little or no market exposure. In 2022, when the S&P 500 was down 18%, the median manager in the relative value market-neutral equity hedge fund universe was up over 1%. 

If we look at private assets, it is harder to find current data given the lags in reporting. But in general, from what we have seen, there is less volatility in 2025 so far. Private assets are typically less volatile for the simple fact that they aren’t valued on a minute-by-minute basis of every trading day. 

While some question the validity of this approach, the month of April was actually a great case study on why this might be a superior method of thinking about your assets. The S&P 500, which is a bellwether of public market exposure in the U.S., started the month at a level of 5,600 and finished April at just under 5,600. So there’s barely any movement at all looking at end point to end point. And yet, during the month, there was a lot of volatility. The level got below 5,000 on April 8, when concerns about the impacts of tariffs were at their most pessimistic. That can create a lot of discomfort for investors. 

Meanwhile, private equity investors wouldn’t have received any feedback on valuation during the month, and so you wouldn’t have had the same level of worry as public market investors.  

Unless you need to sell your investment using a long-term approach that ignores the daily, monthly or even yearly swings, can be a way to not only compound returns more efficiently, but also to enjoy life more, and worry less about things that tend to smooth out over time. 

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Alternatives can benefit portfolios in a number of ways. But for the right type of investor with a long-term timeframe, alternative investments can create meaningful enhancement to a traditional portfolio of assets. 

Alternative investments can provide diversification to traditional assets in a number of ways. For starters, alternative investments are fundamentally different by offering businesses properties or loans that simply aren’t for sale in public markets. And they can give investors access to companies that a good private manager can help shape through their actions to help grow revenues or reduce expenses in a way that public market managers simply cannot do because they’re typically small holders of the overall company. 

Secondly, the return patterns are often quite different from those in traditional assets because there can be a careful reduction of specific market factors, in the case of hedge funds, for example, or their valuations are based on expert appraisal on a less frequent basis in the case of private equity. 

Now, before adding alternatives to a portfolio, investors should understand what each additional idea is bringing to the portfolio in the context of what they are trying to accomplish with their portfolios. Rather than fall into the trap of investing on the latest buzzwords, investors should first ask themselves what they need their money to do for them and how long they have until they need it. This is more important than what products or managers that someone is investing in. 

Start with “why?” For example, if you’re investing for retirement and you’re in your 30s, you might have a 30-year time horizon in front of you to earn, save and invest before you need to take money out, which is a very long timeframe that allows you to consider taking on a different portfolio risk profile than someone who is newly retired and needs investment income for their lifestyle immediately. 

Once you’ve established desired outcomes, understanding the purpose of each investment you are putting in your portfolio is critical. Traditional equities have proven over long periods of time to bring solid returns to long-term investors, and they are liquid. Investors should therefore demand a return premium from their private asset allocations relative to their public market equivalents, since they are trading off liquidity and should be rewarded for this if they are selecting the right strategies. 

Ultimately, if one can take on some degree of illiquidity in their portfolio, greater efficiency can potentially be achieved. According to JPMorgan’s calculations, a traditional portfolio allocation of 60% S&P 500, and 40% U.S. bonds had a return of 8.8%, and volatility of 9.6% over the 1990 to Q3 2024 period. So about 0.92 units of return per unit of risk. If that investor took out 10% from equities and 10% from bonds, and allocated 20% to a combination of private equity, real estate and hedge funds, the portfolio would have achieved a return of 9.2%, with volatility of 8.9% over the same period. 

So a portfolio with a 20% allocation to diversified alternatives achieved better returns than a traditional portfolio. But also importantly, it did so with lower risk, about 1.03 units of return for every unit of risk realized. The evidence that alternatives can improve overall investment outcomes is therefore quite compelling. 

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As with all investments, alternative assets carry potential risks, which is the other side of the coin of potential reward. Risk and reward are inseparable as investment concepts, after all. The risks that are unique to alternative assets are that they are less liquid than public markets. And private asset funds tend to have more concentration or higher allocations to their individual investments than public asset portfolios. 

Leverage, or the use of debt to purchase investments is also typically higher with alternative funds. And fund managers need to be judicious in borrowing money, since it can magnify losses if they get it wrong. But these risks have historically been rewarded over time with the right investments. 

Perhaps the biggest risk for individual investors is not having enough understanding of what they’re buying when they are adding alternative investments to their asset mix. Executing on the Yale Model for an individual investor demands a long-term focus, and individual investors need to have advice because on their own, they don’t have the governance structures that institutional investors have. 

Yes, investment process can slow things down, but in the world of investing, that can be a very good thing to avoid emotional decision making. Individual investors need to keep in mind that while liquidity features are increasingly present in alternative strategies that are available to wealth channel investors, it’s not meant to be used as a way to be extremely tactical with their portfolios. 

So it is best for long-term investors who have the timeframe and the patient mindset that is necessary to realize the benefits of investing, especially when everyone else is worried about uncertainty. It is especially important with alternatives to work with an advisor who is knowledgeable about alternative assets, and who has a network of experts and specialists in alternative assets that they can lean on to dig as deep as possible into the risks to increase the odds of success.

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