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July 18, 2024
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Alternative Investments

The Case for the 40/30/30 Portfolio


Investing has come a long way since 1952 when Modern Portfolio Theory and the traditional 60/40 portfolio was invented. Back then, only 4.2% of the U.S. population owned stocks—today it’s over 60%.

Mutual funds were the first landmark innovation to open markets beyond the Gilded Age’s ultra-wealthy. Index funds then brought simplicity and diversification to families everywhere. In recent years, the internet has expanded access even further, ushering in an age of apps, platforms and instantaneous, commission-free trading with a near-zero barrier to entry.

At each stage in the evolution, these innovations shared a common thread: making markets more inclusive and welcoming more everyday investors to benefit from strategies previously confined to closed circles.

We now stand at the brink of the next big leap—the mainstream adoption of alternative investments. For decades, alternatives like private equity, private credit, real estate and venture capital remained siloed in institutional portfolios, obscured from average investors’ view and access.

But the tide is turning. A recent Bank of America Private Bank study found 80% of young investors are moving toward alternatives, while another study from YouGov found 53% of investors with at least $10,000 in investment assets planned to increase allocations to alts this year.

When I speak with investors, they share with me their goals, desires and fears. This refrain echoes in every conversation between a financial advisor and their client working with the tools available to save, plan, invest and grow generational wealth. To leave their children a better, more prosperous future. I share those same goals in my own family. But reaching these goals keeps getting harder.

The rise of alternatives represents the next milestone on a journey driven by technological advancement, automation and the emergence of new investment vehicles. And just as Modern Portfolio Theory and the 60/40 stock-bond allocation powered portfolio returns for the past era, a new formula is needed to fulfill portfolio potential in this one.

40/30/30 – Ideal Investment Portfolio

For this new environment, where alternatives no longer live behind walled gardens, the 40/30/30 framework stands out in an untraditional world—comprising 40% public equities, 30% fixed income and 30% alternative investments.

New Challenges Testing Old Assumptions

There’s no doubt the 60/40 approach worked well with predictable markets and few alternative assets, but data shows it’s straining under the complexities of today’s markets. Recent years have seen these asset classes moving in tandem at times, both upward and downward.

Compounding this challenge is the unpredictable geopolitical environmentforecasted by McKinsey to intensify in the years ahead. The escalation in geopolitical frictions, from strategic competition between China and the United States to climate risk, is reshaping economic landscapes in unprecedented ways. For investors, this translates to more unpredictable investment outcomes and market turmoil.

Most critically, global inflationary pressures, coupled with shifts in central bank monetary policies, are introducing challenges to the investment landscape not seen since the 1980s. The “higher for longer” interest rate environment is altering the risk-return profile of both stocks and bonds.

The 60/40 portfolio, a safe path to growth depended on for 50 years, is no longer enough.

Alternatives Reach Escape Velocity

Meanwhile, alternative investments are in a period of massive expansion, even in the face of wider economic uncertainty. Institutions and asset managers are doubling down on investing beyond public markets, and the total size of private markets has gone from just a few hundred billion dollars in 2000 to $13 trillion today

Once limited to institutional portfolios, access is expanding rapidly. New fund structures, investment platforms and wealthtech innovations have lowered the barrier to entry for private market participants. Now individuals can add alternatives ranging from private equity and private credit to real estate, infrastructure, litigation finance, art and more to customizable portfolios that sit alongside stocks and bonds.

The appeal is clear: alternatives can enhance portfolios through diversification and reduced correlation to stocks and bonds. The relative illiquidity of private assets allows for patient, long-term strategic management—contributing to more consistent and predictable income streams.

Asset classes like essential infrastructure and real estate are illustrative. Pipelines, ports, apartment buildings or cell towers often have inflation adjustment clauses built directly into their underlying contracts, providing natural hedges. As consumer prices rise, so do their underlying cash flows.

Finding a New Balance: The Rise of the 40/30/30 Framework

Institutions have tapped the power of alternatives for decades—with many allocating over 40% of assets. The 40/30/30 framework makes this institutional resilience accessible to everyday investors.

J.P. Morgan recently found that adding a 25% allocation to alternative assets can bolster 60/40 returns by 60 basis points—an 8.5% improvement to the 60/40 portfolio’s projected 7% return. Similarly, KKR found that 40/30/30 outperformed 60/40 across all timeframes studied.

The 40/30/30 framework represents the next evolution of a process begun nearly a century ago. Less than a decade ago, entering private markets with less than $500,000 was nearly impossible; today, it’s an option for millions of investors. I am proud of the progress we have made.

The future belongs to strategies aligned with access for all. In its diversification, resilience, and growth-potential, the 40/30/30 moves us all closer.

 

Michael Weisz is CEO and co-founder, Yieldstreet



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