The first half of 2024 exposed the difficulties of creating a stable portfolio using just routine allocations to traditional assets. In an uncertain investing environment in which inflation protection, stable income and outsized returns are difficult to source from public markets, alternatives look increasingly attractive.

After a steady wave of disinflation in 2023, more persistent price pressures this year underscore the risks of structurally higher inflation. As noted in our 2024 Outlook, real estate tends to act as an inflation hedge since higher costs can be passed on through higher rents. However, opportunities here extend beyond just inflation protection. Outside of office, other segments of commercial real estate are seeing renewed fundamental tailwinds. Limited home affordability and favorable demand dynamics, such as low unemployment, solid wage growth and immigration, should bolster the already solid renter base for multi-family. Meanwhile, specialized sectors, such as industrials, that are well positioned for a post-pandemic world should see strong demand.

Thanks to worries about reaccelerating inflation, stocks and bonds remained positively correlated. In a world where traditional markets have shown an increased propensity to move together, hedge funds can offer a solution. Hedge fund returns tend to benefit from higher short-term interest rates and elevated volatility; against the backdrop of a longer-than-expected Fed pause, this dynamic, along with their ability to go short, should provide both diversification and return.

Bonds proved once again that they can be unpredictable during periods of heightened inflation uncertainty. That said, transportation and infrastructure assets have established strong track records of dependable income and low volatility, allowing both asset classes to satisfy the need for stability within portfolios.

Against a backdrop of elevated public equity valuations and still-low yields relative to history, private markets can help generate outsized capital appreciation and income. Within private equity, middle market companies that derive the bulk of their returns from value creation instead of financial leverage should do well despite higher-for-longer rates. Private credit can offer attractive yields, although a pick-up in amend-and-extend activity and defaults call for a focus on quality.

As traditional private market exit activity remains subdued, opportunities in the secondary market can give investors exposure to seasoned assets at discounted valuations.

In a lagged reflection of public markets, repricing across private markets is still underway, but some sectors are moving faster than others. Prospects in real estate look brighter. Office remains an issue, but valuations in other segments are stabilizing, and managers with available liquidity can acquire quality assets at attractive prices. After valuations came down in 2023, private equity purchase price multiples retraced higher in early 2024 and are holding up well. However, a rebound in exit activity may force sellers to realize lower multiples. The rerating in private credit is still in its early stages, although rising default risk and the increased likelihood of higher-for-longer interest rates suggest that a more marked adjustment may be forthcoming.

Nonetheless, there are plenty of attractive opportunities waiting for investors across the alternatives landscape. Much like an investor should focus on finding highquality assets, asset allocators should strive to invest in high-quality managers. Indeed, manager dispersion is particularly wide in private markets, making investing with a good manager a key element of the allocation process (Exhibit 1).

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