In periods of market uncertainty, the ability to tactically adjust a portfolio's exposure is invaluable. By incorporating hedging and tactical asset allocation, these investments can help smooth returns and mitigate overall portfolio risk.
In Brief
- Significant asset class volatility presents challenges for traditional 60/40 portfolios, echoing the simultaneous impact on equities and bonds in 2022.
- Alternative assets provide an opportunity to enhance portfolio diversification and risk management during periods of market volatility.
- Fixed income liquid alternatives use duration management, broader investment options and hedging strategies to capture alpha or limit drawdowns in volatile markets.
The volatility across asset classes has been significant this year. In April, the U.S. equity volatility index (VIX) reached its highest level in almost a decade, while the comparable index for U.S. bonds reached its highest level in five years (Exhibit 1). Although volatility in equities is unpleasant, it is not uncommon. However, increased volatility in bonds, which are typically considered a defensive component of a portfolio, presents a greater challenge when trying to protect against market risks.
This persistent volatility has made the traditional 60/40 portfolio a bumpy ride for investors in 2025. A 60/40 portfolio of U.S. equities and bonds was down 5% year-to-date through April 22, and for some, the memories of 2022 are still fresh. In that year, higher inflation caused the correlation between stocks and bonds to become strongly positive, leading to significant declines across both asset classes.
As the market continues to grapple with U.S. policy uncertainty and assess the implications for economic growth, inflation, and fiscal deficit and debt positions, volatility is likely to persist, and asset correlations could deviate from their historical long-run positions.
During times of elevated volatility and positive correlations across public markets, non-traditional strategies can be utilized to enhance portfolio diversification. We have previously discussed options in real assets, like infrastructure, which offer fixed-income-like diversification benefits. However, for investors with higher liquidity demands, there are other options in liquid alternative strategies. Liquid alternative strategies can provide capital preservation and potential gains during volatile markets.
What are “liquid alts”?
Liquid alternatives, or "liquid alts," are investment strategies designed to provide diversification and risk management benefits similar to hedge funds, but in a more accessible and liquid format.
They combine the accessibility of mutual funds with sophisticated strategies to manage risk and capitalize on opportunities that can arise in volatile markets when assets may be mispriced relative to their fundamentals.
In periods of market uncertainty, the ability to tactically adjust a portfolio's exposure is invaluable. By incorporating hedging and tactical asset allocation, these investments can help smooth returns and mitigate overall portfolio risk.
What are fixed income “liquid alts”?
The U.S. bond market has experienced notable fluctuations in recent years, particularly at the longer end of the yield curve. In early April, over a three-day period, the yield on the 30-year U.S. Treasury increased by 47 basis points, a change not seen since the onset of the COVID-19 pandemic. Meanwhile, spreads in credit markets have widened, but only to historical averages, suggesting the market may not be fully pricing in a recession and could still be susceptible to spread volatility.
These conditions can be challenging for bond investors, but fixed-income-focused liquid alternatives employ various strategies to generate alpha in choppy markets that are uncorrelated with the broader fixed income market:
Actively managed duration exposure: Shortening duration can protect against rising rates, while extending duration can capture gains when yields fall. In periods of higher volatility, some strategies can maintain a near-zero duration when appropriate.
Broad investable opportunity set: Liquid alternative strategies can invest across a wide range of global fixed income markets and sectors. This flexibility allows them to capture alpha in less-explored parts of the market, including derivatives such as credit default swaps and niche areas of markets such as securitized credit that are not widely covered by analysts.
Strategic credit allocation: Managers can dynamically shift between investment-grade, high-yield and structured credit, based on where they see value, without the constraint of following a particular benchmark. Unconstrained liquid alternatives can add to specific qualities, sectors, or maturities where they see the opportunity to generate returns.
Hedging: Strategies can employ hedging to limit exposure as part of a disciplined approach to risk management. This can include dedicated short positions (to limit volatility and drawdown) as well as a strategic allocation to cash (to be deployed when volatility creates opportunities for alpha generation).
Investment implications
Liquid alternative strategies enable investors to quickly adjust their risk exposure, while managing volatility and enhancing diversification. This makes them a valuable stepping stone out of traditional markets and towards private market alternatives.
Research by Morningstar found that liquid alternatives demonstrated resilience during the 2022 60/40 market downturn, with many strategies outperforming traditional equity and bond indices.1
The breakdown in the negative correlation between bonds and equities has challenged traditional portfolio construction techniques and the ability to insulate portfolios during periods of market volatility. However, non-traditional strategies can be used to reintroduce diversification back into portfolios.