Considerations and questions for new alternatives investors
This analysis was originally written for our 2026 Long-Term Capital Market Assumptions. You can read the full report here.
New (or newer) investors in alternatives include high net worth investors (surveys show only a 2% average allocation to alternatives for this type of investor1) as well as broad investor access via retirement plans such as 401(k)s and European Long-Term Investment Funds (ELTIFs). For new or newer investors, the task at hand – putting the puzzle pieces together to build a portfolio that includes alternatives – may seem a bit daunting.
These investors should consider where they are in this journey and which specific allocation breakdown makes sense for them:
- How much of an allocation to alternatives is appropriate? There is no one-size-fits-all allocation profile. Considering individual liquidity needs at the outset is key. While the liquidity of different alternatives products has improved with more evergreen funds and the growth of secondary markets, some fund commitment times can be as long as 10–12 years (for closed-end funds). That time may be needed to fully reap the rewards of adding private markets to a portfolio. Here, experience with individual investors (especially the very high net worth cohort) is instructive. In practice, to calculate the maximum allocation to alternatives, an investor can estimate annual spending needs, assume they could only be funded from the public side of the portfolio and run scenario analysis on the whole portfolio. An investor may conclude that – based on how much illiquidity they can accept – 5%, 10% or 20% or more in alternatives makes sense for them.
- Exactly which types of alternatives should be included? Rather than focus on individual categories, such as private credit, private equity or real estate, a useful framework for evaluating which alternatives to add to a portfolio would instead consider the characteristics of different alternative assets and the roles they can play in a portfolio: income, growth (alpha) or diversification. For investors with an income-oriented goal, fixed income-like alternatives such as core private credit or real assets can boost overall portfolio yield. For those with a growth-oriented goal, equity-like alternatives such as private equity and venture capital can produce the strongest returns across market cycles. And if the goal is to enhance portfolio resilience, real assets (such as real estate, infrastructure and commodities) and absolute return hedge funds can offer returns that are uncorrelated to public markets.2 Across all scenarios, a diversified alternatives allocation offers a wider range of enhanced investment outcomes relative to stand- alone alternatives.
- How should that new allocation be funded from the public side? By alternating the funding source (stocks, bonds or a combination), adding alternatives can result in significantly different outcomes for an overall portfolio’s return and volatility. Investors should not ignore volatility issues when constructing diversified portfolios that include alternatives: The overall portfolio’s volatility can inadvertently increase depending on the alternative assets added and where they are funded from. In private markets, defining “volatility” can be challenging, given more infrequent mark-to-market practices. In our LTCMAs, we use unsmoothed measures of volatility, which better reflect the underlying volatility of assets. In addition, we consider the correlation between different alternative assets and public assets when thinking about the potential impacts on overall portfolio volatility.
Adding a fully diversified alternatives allocation to a public portfolio can boost returns while lowering overall portfolio volatility, as shown in Exhibits 1A and 1B. But achieving these valuable objectives does not happen by accident; rather, it requires investors to address several complicating factors that make successful implementation a challenge:
- The fund structure matters. Different types of funds, from evergreen to drawdown, have different trade-offs for access, liquidity, distributions and tax efficiency. One type of fund may work better than another for a given alternative strategy or asset class.
- Be aware of the details. In practice, investors can see very different net returns from alternatives products once fees and leverage are considered.
- Manager selection makes all the difference.
Most sectors of private markets exhibit significant manager dispersion and therefore require skilled manager selection. The spread between the top- and bottom-quartile manager is exceptionally large outside of high quality, income-oriented alternatives. For example, public equity has approximately 200bps of performance dispersion between top- and bottom- decile managers over the last 10 years. That concept for private equity has exhibited 1,960bps of dispersion. Said another way, that’s almost 10 times the amount of dispersion between public and private equity markets. Investors should be aware of the fund style (core to value-add), as this can materially affect the behavior of the investment. - Rebalancing might not be so easy. A private market allocation can make rebalancing more challenging, given illiquidity considerations. Investors should assume only a small percentage of quarterly liquidity for private market allocations and define thresholds of acceptable portfolio drift between their public market and private market exposures. Liquidity considerations might require more frequent rebalancing in the public market portion of the portfolio than would otherwise be the case.
- Taxes can get even more complex. Even tax-exempt institutions must consider tax issues from alternatives that employ leverage (that is, most of them). Tax considerations are important in private markets as well and can vary based on the vehicle used and the tax jurisdiction.