Multi-Asset

Evolving 60/40 with Alternatives

Mar 20, 2025|ByMichael Gates, CFA

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The next evolution of 60/40: “liquid alts & gold & bitcoin, oh my”

Modern Portfolio Theory was introduced in the early 1950s by Nobel Prize-winning economist Harry Markowitz, whose seminal research emphasized portfolio diversification to cleverly maximize returns and mitigate risk. This investment framework started to become increasingly popular in the 1990s, benefiting from a regime of low inflation, declining interest rates, and negative correlations between stocks and bonds. Over the proceeding decades, the 60/40 portfolio concept grew into an industry standard asset allocation strategy for investors seeking a balanced and diversified portfolio with a growth bias.

But things have changed.

The macro environment in early 2025 of higher rates, sky-high government deficits, and increased geopolitical uncertainty amidst stricter monetary policy and still above-average inflation creates a starkly more challenging environment for those classic 60/40 strategies to replicate the same historical success.

An evolving world requires evolving strategies.

For Michael Gates, lead portfolio manager of the Target Allocation model portfolios, and his dedicated team of asset allocation researchers, this means constructing more modern portfolio solutions that incorporate alternatives.

To do this, the team leverages a rigorous, multi-step quantitative and qualitative investment process, supported by dozens of seasoned investment professionals, strategically calculated screening methodologies, and decades of time-tested portfolio construction research. The process for how the team seeks to enhance a traditional stock/bond portfolio with alts can be broken down into three core steps: sourcing, screening, and sizing.

Sourcing (“What should I consider selling?”)

Higher and more volatile interest rates with a backdrop of increasingly precarious government deficits and moderating but still above-trend inflation can create a hostile environment for bonds – which makes them our primary targeted funding source. Swapping bonds for bond-like alts gives us an extra lever to recalibrate overall portfolio duration, curb volatility, and seek more diversified drivers of return.

As we decrease our allocation to bonds and increase our allocation to bond-like liquid alts (like market neutral, merger arbitrage, and long/short active manager strategies), we also evolve the complexion of the bonds we hold, reallocating to higher-quality and longer-duration exposures (while still thoughtfully balancing rate risks using proprietary Aladdin technology). The outcome is a bond sleeve that is of course smaller to accommodate our newly added alts sleeve but also fundamentally reconstructed to still potentially deliver needed resilience in an adverse scenario of a low growth/recessionary environment.

Alongside bond-like alts, we think small allocations to gold and bitcoin can also serve a complementary role and potentially provide distinct and additive sources of diversification. However, we view the funding sources being different due to their respective volatility profiles. Gold, similar to bond-like alts, could be funded from bonds while bitcoin would understandably be funded from higher volatility stocks.

Screening (“How to choose what to buy?”)

Unlike the more neatly delineated stock and bond complexes, the universe of alternative investments is incredibly heterogenous, spanning an array of asset classes, management styles, and vehicle structures. This diversity means alts can be used to accomplish a wide variety of portfolio objectives. It also means that vehicle screening and selection can be a resource-heavy exercise - particularly with active manager strategies - requiring more precision and operational due diligence than is necessary for an ordinary stock or bond fund.

In our Target Allocation model portfolios that include alternatives, we start with an opportunity set of more than 500 so-called “liquid alternative” ETFs and mutual funds. From there, we apply a series of quantitative and qualitative screens and filters that produce a curated universe of managers with consistent, demonstrable skill, justifiable fees, and robust operational infrastructures. Since we are primarily funding our alts allocation from bonds, we aim to find true diversifiers with reasonably similar volatility profiles: strategies that can provide access to low correlated sources of return that have historically exhibited defensive characteristics similar to bonds.

Separate from active manager strategies, as mentioned earlier, we think some investors should also consider scarce assets such as gold and bitcoin as another compelling form of diversification given the current macroeconomic backdrop. Central banks (particularly China and Russia) have been purchasing gold at a historic rate the last few years¹, and we don’t expect this trend to abate anytime soon given rising debt and de-dollarization concerns and the increasingly complex geopolitical landscape. We believe bitcoin can also benefit from these themes, and we expect their similar ‘store of value’ narratives will continue to resonate with more investors in more places, with bitcoin specifically potentially benefiting from baby boomer-to-millennial wealth transfer tailwinds and a new “crypto-friendly” administration primed to ease regulatory bottlenecks that have constrained investor participation.

Sizing (“How much should I consider allocating?”)

Alts funds that successfully pass the screening and due diligence stages are then re-evaluated from a whole portfolio perspective, taking into consideration how these funds are expected to co-move with stocks and bonds. For the selected alts to effectively serve their intended role, proper sizing of the alts sleeve within the broader stock/bond portfolio is imperative. To achieve this, we run a two-step optimization process that first suggests the best vehicles and ideal weights and then second re-scales the size of the allocation to fit within our intended alts sleeve and produce the optimal risk-adjusted return for the whole portfolio. In other words, we purposefully calibrate the alts allocation to most effectively complement the specific strengths and weaknesses of the stocks and bonds in the portfolio.

What does this look like in practice? Typically, the largest allocation to alternatives in our portfolios is in moderate growth profiles (such as a 60/40 portfolio) where the alts sleeve may approach roughly 50% of the fixed income benchmark allocation. But the size of the alts allocation isn’t static or cascaded pro rata across all risk-profiles. Instead, the alts allocation usually gets smaller on a relative basis as you move to the more conservative or more aggressive ends of our portfolio risk spectrum, as investors are either inherently more defensive in nature or as the funding source for alts (i.e., bonds) becomes meaningfully reduced, respectively.

Conclusion

The world is quickly changing, and yet investors’ need to achieve their desired financial outcomes remains. With the precedent drivers of performance fundamentally different today, we believe the success of yesterday’s 60/40 portfolio could be more challenging. But that doesn’t mean a balanced growth portfolio can’t still flourish – we simply believe investors need to be more thoughtful and creative in their allocation approach. We seek to do just that by evolving the 60/40 portfolio with the added diversification benefits of liquid alts, gold, and bitcoin.

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