Public Equities, or Stocks, on the other hand, while historically have been a good source of excess return, are also prone to extreme volatility, and can have long periods where the broader market as measured by the index does not earn any positive return. As such, it is generally not an appropriate or desirable asset class to have all of one’s wealth in one volatile asset class such as public equity. Bear markets can take long periods of time to recover and the drawdowns can be very significant, sometimes more than 50% on a peak to valley basis. For example, the bear market of 2008, the drawdown period took seven years for the indexes to regain their pre-bear market levels. Also, the ability to diversify within public markets has become increasingly difficult as equities across countries and sectors have become highly correlated, i.e., They move in the same direction at same time. Adding more equities to your portfolio is unlikely to improve diversification, or reduce risk in a meaningful way, and instead, merely converges the portfolio return to that of the broader index.

However, adding other asset classes with strong return profiles, that are uncorrelated, or less correlated, with stocks and bonds, can add proper diversification to reduce volatility and potentially downside risk. Alternative
asset classes like real estate, private debt , private equity, infrastructure and other have historically had distinctly different return streams than stocks and bonds, and thus can smooth out the return profile of the resulting portfolio to achieve a better outcome than the traditional 60-40 approach. To put it a different way, adding non-correlated alternative assets can push out the efficient frontier and help a portfolio achieve a higher return with the same level of risk, or the same return with a lower level of volatility and risk.

And finally, while we tend to focus on the risk management benefits of alternative asset classes, alternatives can often be a strong source of return as well as an alternative source of income. Given that alternatives are not as widely held as traditional asset classes, the opportunity to find alpha is greater, as mispricing doesn’t get arbitraged away as quickly as it does in public markets. While securities in public markets are well covered and analyzed by many buy and sell-side analysts, alternative asset classes often have less coverage and are less understood. Alternatives also tend to be less liquid, creating buying opportunities at a significant discount to intrinsic value.

Ultimately, alternatives assets provide additional sources of total return, but more importantly, allow an investor to properly diversify beyond just stocks and bonds to create a smoother return profile for their portfolio.