Democratizing Diversification: Q3 Alternative & Private Investment Outlook

“The idea that there are other universes, perhaps with different laws of physics, seems to be gaining widespread acceptance.”

By Scott Welch, CIMA®, Chief Investment Officer & Partner

Reviewed by Carter Mecham, CMA®, IACCP®

The “democratization” of alternative and private investments is in full swing. The growth and evolution of semi-liquid “evergreen” solutions has opened up the possibilities of private markets investing to a much wider audience of potential investors than existed when these types of strategies were available only to “Qualified Purchasers” (QPs), which were limited to institutional investors, sovereign wealth funds, pensions, endowments, and ultra-high net worth families.

But that has changed, and we have now reached a point where the Department of Labor (DOL) has agreed to allow private investments to be included in ERISA accounts (IRAs, 401Ks, etc.). This has the potential to be a seismic change in the investment landscape, though there is much to be deliberated, debated, and discussed and, in our opinion, the law of unintended consequences is fully in play.

So, as we move through the remainder of 2025 and into 2026, it is worthwhile checking in on the current and potential future state of alternative and private market investments.

A Reminder of the Potential Value of Including Alts & Privates into Diversified Portfolios

We think the first place to start is to examine what the future potential return of the public equity market might be. In several previous blogs, we’ve reviewed the current state of the economy, the Fed, interest rates, inflation, and earnings – what we believe are the five primary “signals” as to the current state of the markets.

But let’s remind ourselves that the future potential upside of any investment depends on the price you pay for it today and, at least in the public equity markets, valuations are high across the global spectrum.

Source: Morgan Stanley Eaton Vance “The Beat,” as of June 2025. You cannot invest in an index and past performance is no guarantee of future results.

What this translates into is that current valuations correspond to muted expected equity market returns over the next ten years.

Source: JP Morgan “Guide to Alternatives “, as of May 31, 2025. You cannot invest in an index and past performance is no guarantee of future returns.

Now let’s re-introduce the concept of “economic regime” investing. The idea is that, at any given time, the economy is either expanding or contracting, and inflation is either rising or falling.

Source: Certuity. For illustration purposes only.

We can then overlay this schematic with which types of investment strategies have the potential to perform best during each phase of the economic cycle.

Source: Certuity. Definitions: “Capital Growth” = Equity strategies, “Income” = Rate and Credit strategies, “Real Assets” = commodities, precious metals, real estate, MLPs, etc., “Volatility Management” = alternative and private investment strategies. For illustration purposes only – does not represent investment advice.

The overall strategic objective is to build “all-weather” portfolios that perform consistently regardless of where we are in the economic cycle.

Remember the power of compounding – if you don’t lose as much in a down market, you don’t have to make as much in an up market to still come out ahead over time.

Source: Nationwide IMG Competitive Intelligence Team.

The potential benefits of incorporating alts and privates into diversified portfolios vary depending on the strategy. In the case of so-called “alternative investments” (long/short equity, global macro, managed futures, event-driven, option-based, etc.), the primary value proposition is lower correlation to traditional stocks and bonds, thereby potentially increasing the diversification of the overall portfolio.

But what do we really mean by “alternatives?” In our opinion, alternative investments are simply less constrained active management strategies.

In other words, there is nothing particularly “alternative” about them. They just have greater flexibility to deploy a variety of investment approaches.

Source: Fortigent and Certuity. For illustration purposes only.

In the case of private investments, the potential benefits are the ability to take advantage of illiquidity and leverage, which historically have provided excess performance and/or yield versus more traditional investments. Many market participants expect this excess performance to continue.

Source: iCapital, data as of April 2025. You cannot invest in an index and past performance is no guarantee of future results. These figures represent estimated projections of future performance.

Sources: MSCI Indexes, MSCI Private Capital Solutions, Cliffwater, NCREIF, Bloomberg, Macrobond, PitchBook. Analysis by Franklin Templeton Institute. Data as of December 31, 2024. Notes: For each period, the top three returns are marked in green, while the bottom three returns are marked in orange. Returns exceeding a year are annualized. The indexes are total returns in US dollar terms. All returns are net of fee assumptions as gathered by Franklin Templeton, valued on a quarterly basis. Indexes are unmanaged and one cannot directly invest in them. Past performance is not an indicator or a guarantee of future results.

The potential diversification benefit of including alternatives and privates into a portfolio can be illustrated by showing the historical correlations between these markets and the public markets.

The net result of including alts and privates is a potential improvement in the overall risk/return profile of a diversified portfolio.

Source: Bloomberg, Burgiss, FactSet, NCREIF, PivotalPath, Standard & Poor’s, J.P. Morgan Asset Management. The alternatives allocation includes hedge funds, real estate, and private equity, with each receiving an equal weight. Portfolios are rebalanced at the start of the year. Equities are represented by the S&P 500 Total Return Index. Bonds are represented by the Bloomberg U.S. Aggregate Total Return Index. Volatility is calculated as the annualized standard deviation of quarterly returns. Past performance is not a reliable indicator of current and future results. Data are based on availability as of May 31, 2025.

Source: Burgiss, Clarkson, Cliffwater, Drewry Maritime Consultants, FactSet, Gilberto-Levy, MSCI, NCREIF, PivotalPath, J.P. Morgan Asset Management. Correlations are based on quarterly returns over the time period indicated. A 60/40 portfolio is comprised of 60% stocks and 40% bonds. Stocks are represented by the S&P 500 Total Return Index. Bonds are represented by the Bloomberg U.S. Aggregate Total Return Index. 10-year annualized returns are calculated based on the time period indicated. “Absolute Return Hedge Funds” represent asset-weighted returns from the PivotalPath Global Macro and Relative Value indices. “Directional Hedge Funds” represent asset-weighted returns from the PivotalPath Credit, Equity Diversified and Event Driven indices. Direct Lending uses yields from the Cliffwater Direct Lending Index. All other indices and data used for alternative asset class returns and yields are as described on pages 12 and 16 of the Guide to Alternatives. Yields are based on latest available data as described on page 12 of the Guide to Alternatives. Transportation returns are shown on an unlevered basis, and returns can be enhanced by adding leverage. *CML is commercial mortgage loans tracked by the Gilberto-Levy Commercial Mortgage Index. Past performance is not a reliable indicator of current and future results. Data are based on availability as of May 31, 2025.

Source: Bloomberg Index Services Limited, Cliffwater Direct Lending Index, FTSE Russell, Hedge Fund Research (HFR), MSCI, NCREIF, Preqin, iCapital Alternatives Decoded, with data based on availability as of Apr. 30, 2025. Note: Data as of December 2025 and is subject to change based on potential updates to source(s) database. Return and volatility is annualized and is based on quarterly data. Buyout is proxied by Preqin Private Equity Buyout Index. Growth is proxied by Preqin Growth Equity Index. Venture proxied by Preqin Venture Capital Index. Secondaries proxied by Preqin Secondaries Index. Direct Lending is proxied by Cliffwater Direct Lending Index. Distressed proxied by Preqin Distressed Private Debt Index. Real Estate proxied by NCREIF NFI-ODCE Index. Infrastructure proxied by Preqin Infrastructure Index. Private Timber proxied by NCREIF Timberland Property Index. Private Farmland proxied by NCREIF Farmland Property Index. Macro HFs is proxied by HFRI Macro Total Index. Multi Strat HFs proxied by HFRI RV: Multi-Strategy Index. Event Driven HFs proxied by HFRI Event-Driven Total Index. Equity Hedge HFs proxied by HFRI Equity Hedge Total Index. Credit HFs proxied by HFRI Credit Index. Global 60/40 proxied by 60% MSCI ACWI Net Total Return USD Index and 40% Bloomberg Global Aggregate Index. Cash proxied by the FTSE 3 Month US T Bill Index. Annualized risk and returns above are based on indices that are meant to estimate the asset class performance, hypothetically creating a return if one had access to all funds. Not all the above are practically investable. For more information, please refer to the Index Definitions, Attributions, and Important Information sections at the end of this deck. For illustrative purposes only. Past performance is not indicative of future results. Future results are not guaranteed.

Where We See Current Opportunities

Alternative Investments

Despite “noise” around the numbers, we believe we may have entered a market regime marked by generally higher volatility and higher interest rates – a regime where alternative investments historically have performed best, especially in terms of diversification benefits.

Source: Ycharts, 12-month data through August 5, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Source: Bloomberg, CBOE, FactSet, MSCI, PivotalPath, Standard & Poor’s, J.P. Morgan Asset Management. Monthly VIX reading is an average. (Top Chart) Macro hedge fund relative performance volatility is since 6/30/1998. Numbers may not sum to aggregate total return due to rounding. Global equity index = MSCI All Country World Index. 60/40 portfolio = 60% S&P 500 Total Return Index and 40% Bloomberg U.S. Aggregate Total Return Index. Past performance is not a reliable indicator of current and future results. Data are based on availability as of May 31, 2025.

Source: JP Morgan “Guide to Alternatives,” as of May 31, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Thus far in 2025, alternatives (i.e., hedge funds) have performed as expected, generating consistent returns with lower-than-equity volatility, providing the diversification benefits we expect from these strategies.

Source: FEG, through June 2025. You cannot invest in an index and past performance is no guarantee of future results.

The nature of our client base leads us to search for quality multi-strategy solutions versus building a diversified portfolio from single strategy managers.

Private Credit

We have been advocates of private credit versus the public market for quite some time, and we maintain that conviction. However, it may be true that the dominant “space” within private credit – the PE-sponsored direct middle market lending space – is getting “crowded” due to massive inflows over the past 3-4 years.

At the “median” level, we are witnessing a slight deterioration of pricing, credit quality, and deal structure. But quality managers continue to find excellent opportunities on appropriate terms, and we remain active in that space.

In addition, we have expanded our searches into more specialized or “niche” lending markets (e.g., asset-based lending, triple net leases, technology lending, government receivables financing, etc.), with positive results.

Source: JP Morgan’s “Guide to Alternatives,” as of May 31, 2025. Private investments may carry additional liquidity and leverage risks and are often limited to more sophisticated investors accordingly. Past performance is no guarantee of future results.

Sources: Franklin Templeton, Clilffwater, Morningstar, PitchBook LCD, ICE BofA Indices, as of December 31, 2024. Notes: Indexes are unmanaged, and one cannot directly invest in them. They do not include fees, expenses, or sales charges. Past performance is not an indicator or a guarantee of future results.

Private Equity

We continue to be active in searches for quality private equity solutions across a variety of sub-sectors, including sports investing, infrastructure, real estate, secondaries, and GP Stakes.

• Sports Investing: This entails lower correlated strategies, a growing opportunity set, and a differentiated solution. Team valuations, fan viewership, sponsorship opportunities, and media rights are driving explosive growth in this space. We have been active in this space and continue to seek additional opportunities.

Source: iCapital Market Pulse: Private Equity’s Next Foray – Sports Investing, February 2025.

Source: iCapital Market Pulse: Private Equity’s Next Foray – Sports Investing, February 2025.

Source: iCapital Market Pulse: Private Equity’s Next Foray – Sports Investing, February 2025.

• Infrastructure: We are specifically interested in energy infrastructure, due to the exploding demand for energy, transmission, and AI data centers.

Source: iCapital Market Pulse: Building Tomorrow – The Multi-Trillion-Dollar Infrastructure Opportunity, February 2025.

• Real Estate: We believe this sector is poised for a comeback following its “beat down” during COVID. We are currently researching growth/value-added equity solutions.

• Secondaries: The traditional “exit ramps” for many private equity strategies – the IPO and M&A markets – have been less active for the past few years. Thus, as sponsors seek to generate liquidity for distributions and/or to launch new funds, we continue to believe there are attractive opportunities available in the secondaries space, and many strategies are available at interesting discounts.

Source: Franklin Templeton and Mizuho Greenhill, as of December 31, 2024. You cannot invest in an index, and private investments may carry additional liquidity and leverage risks and are often limited to more sophisticated investors accordingly. Past performance is no guarantee of future results.

• GP Stakes: These funds acquire minority ownership interests in asset managers operating across the private markets landscape, including private equity, private credit, real estate, and infrastructure. It’s a rapidly growing space as the selling funds seek permanent expansion capital. Investors receive a pro rata share in management fees, upside in the underlying investments, and in the growth of the sponsor fund itself.

The Importance of Diversification and Manager Selection

As a quick reminder, manager selection within the alternative and private market investment spaces is of critical importance. Unlike the public markets, (a) the performance dispersion between the top quartile and bottom quartile managers can be dramatic, and (b) historically, within the private market space, top quartile managers have shown a consistency of top performance.

Source: Burgiss, Morningstar, NCREIF, Pitchbook | LCD, PivotalPath, J.P. Morgan Asset Management. Global Large Cap Equities and Global Bond are based on the Morningstar Global Large Stock Blend and Global Bond (not hedged) categories, respectively. U.S. Core Real Estate is based on the NCREIF Fund Index – ODCE. Global Private Credit is represented by Pitchbook | LCD fund data. U.S. Non-core Real Estate, Global Private Equity and Global Venture Capital are based on indices from the MSCI Private Capital Universe. Hedge Funds are based on the PivotalPath index. *Manager dispersion is based on annual returns over the 10-year period indicated for: Global Large Cap Equities, Global Bond, U.S. Core Real Estate and Hedge Funds. Manager dispersion is based on the 10-year internal rate of return (IRR) ending 4Q24 for: Global Private Credit, U.S. Non-core Real Estate, Global Private Equity and Global Venture Capital. Past performance is not a reliable indicator of current and future results. Data are based on availability as of May 31, 2025.

We also emphasize the importance of diversification when investing in private equity, across three dimensions. Private equity is not a “one and done” strategy – the risk is too high. To appropriately invest in private equity, investors need to diversify across managers, strategies, and – perhaps most importantly – across vintage years.

The appropriate portfolio construction approach is to build a diversified mix of allocations and then, as the initial investments reach their distribution phases, to use those distributions to “self-fund” future vintage year investments.

Summary and Conclusions

We are long-time advocates of the strategic inclusion of both alternative and private market investments into the construction of diversified portfolios, and we hope this blog successfully summarizes why we feel that way.

From a portfolio construction perspective, the allocation amounts of these strategies are dependent on client objectives, risk/return objectives, and liquidity constraints.

But, as a starting point and given a “blank sheet of paper”, we generally recommend a 15-25% allocation to these types of strategies – large enough to “move the needle” with respect to the risk/return profile of the overall portfolio, but not so large as to create “illiquidity anxiety” for most investors of appropriate net worth and investable capital.

We’ve also tried to summarize and support where we believe the best current opportunities are in these ever-evolving markets.

As always, we welcome your questions and feedback.