Constructing an alternative portfolio

5 MINUTE READ

A look back

All of this helped you gain a strong understanding of the foundational principles underpinning alternative products.

Now it’s time to piece the blocks together and see how these sub-asset classes combine to solve outcomes within a portfolio context.

Before we do so, let’s refresh on the three main reasons investors should consider alternatives for their portfolio in today’s landscape.

In other words, investors – like you – may need to consider new strategies.

Introducing alternatives to a portfolio with a challenge to solve

Let’s put it into practice. The below scenario demonstrates increasing income through an illiquid portfolio by introducing alternative investment solutions.

Fun fact

A BlackRock Capital Assumptions Analysis states that from the 60/40 portfolio (Public markets: 60% equity, 40% bonds) we can currently expect a 5% return¹.

The alternative solution

Take a full-portfolio approach by introducing private markets exposures.

By diversifying a traditional 60/40 portfolio with private markets exposures that are aligned to the desired investment outcomes, the investor was able to increase their expected returns and mitigate risk by diversifying assets and moving beyond traditional investment products like stocks and bonds.

By incorporating a range of income-oriented private assets such as brownfield infrastructure equity, mezzanine, corporate debt, and three types of income-oriented real estate strategies, the risk/return profile increases from 0.44 to 0.66.

Source: Forecasts are not a reliable indicator of future performance. Risk calculated using BlackRock’s risk management platform, Aladdin. Indicated systematic risk exposures and the market based risk factor changes and are meant to predict the performance of illiquid investments if they were traded in the public market as of 30/9/2021, from the trailing 72 months of data. It does not represent accounting volatility based on quarter over quarter valuation marks. BlackRock expected market return information is based on BlackRock’s 5 year capital market assumptions as of September 2021, which are subject to change. Private Market expected returns are gross of fees. Capital Market Assumptions are sourced from BlackRock Investment Institute. There is no guarantee that the capital market assumptions will be achieved, and actual risk and returns could be significantly higher or lower than shown. Hypothetical portfolios are for illustrative discussion purposes only and no representation is being made that any account, product or strategy will or is likely to achieve results similar to those shown. Purpose is only to demonstrate the potential benefits of adding private markets to a 60/40 portfolio.

Allocating to alternatives

This is just one of the many ways you can incorporate alternatives into your investment strategy to fit both your long and short-term goals. When determining allocation to alternatives in typical public portfolios, investors have common questions such as:

• What is the appropriate allocation to alternatives for my specific portfolio?
• Which asset classes should I consider, and what is the right mix?
• How do I implement a strategy, and how long will it take?
• How can I efficiently maintain my target exposure to alternatives?

These portfolio allocation questions are critical and key to understanding why various alternative investments are being incorporated. Below is a helpful review of alternatives and the investment objectives they can meet:

Exposure to private markets focused on enhancing income, for example, can improve levels of risk return. Just as adding one stock or mutual fund does not lead to significant diversification, a single alternative investment does not give you blanket exposure to the full asset class. Different alternative investments deliver different portfolio outcomes - look to build a diversified approach to the asset class.

Case study: Diversifying a 60/ 40 portfolio with private markets allocation

The goal here was to potentially generate more income by integrating private markets strategies with a 20% allocation.

In this case, the total return of the portfolio increases from 4.6% to 5.3%, while the risk return increases by .09.

Improved risk return

While some alternatives can experience higher levels of volatility than traditional equities and bonds, as a group they may not necessarily be more volatile than any other investment. In fact, many alternatives experience far less volatility than the stock market.

In the below example, in stress-test situations when the VIX, a measure of the stock market's expectation of volatility based on S&P 500 index options, increased by 30%, the portfolio with exposure to alternatives showed a smaller decrease in performance.

Case study: Stress test