In 1952, Harry Markowitz published a paper titled “Portfolio Selection,” setting out the basics of what would become Modern Portfolio Theory — work that would later earn him the Nobel Prize. The objective of Modern Portfolio Theory is straightforward: construct the combination of assets that produces the highest expected return for a given level of risk. Diversification is its bedrock. Uncorrelated or negatively correlated assets, combined in the right proportions, can meaningfully reduce overall volatility — producing a smoother, more consistent return profile than any single asset alone.
For most of the past forty years, that arithmetic was reliably satisfied by two asset classes: equities for growth, and bonds for income, lower volatility, and the diversification benefit of being something other than equities. That pairing — usually framed as the “60/40” portfolio — became the default definition of a diversified allocation and the benchmark against which everything else was measured.
The conditions that made it work are no longer fully present. This report is about what comes next.
The case for bonds, and where it weakened
Investors have always incorporated bonds into their allocations for three reasons: income, lower relative volatility, and diversification against equity risk. The third was the most important. From the late 1970s onward, declining interest rates lifted bond prices through a long, mostly uninterrupted bull market. Between 2000 and roughly 2020, an unusually accommodative monetary regime produced something even better: a sustained period in which equities and bonds were negatively correlated. When stocks fell, bonds tended to rise. That was the foundation of the 60/40 portfolio’s reputation.
Since 2022, that relationship has broken down. Stocks and bonds have moved together with increasing frequency — both falling in coordinated drawdowns, both rallying in coordinated rebounds. The historical pattern of bonds providing offset has, for now, given way to a pattern of bonds providing correlation. At the same time, the income that bonds once provided has rebuilt only partially, and the long structural tailwind from falling rates has reversed into a structural headwind from a higher rate floor.
Bonds remain essential to most allocations. But the question facing any serious portfolio is no longer “stocks or bonds” — it is what else belongs alongside them.
What we mean by alternatives
“Alternative Investments” is a deliberately broad term, encompassing any strategy that falls outside traditional, long-only public markets. Alternatives have risk/return characteristics that do not behave like conventional asset classes and that require specialized skill to select and implement. A thoughtfully constructed alternatives sleeve can add diversification, generate income, and provide exposure to return streams that compound differently from public markets. A poorly constructed one will simply add fees and complexity, and underperform over time.
Highbrook organizes its alternatives work into three primary strategies, distinguished by liquidity tier and underlying exposure:
1. Liquid alternatives (daily liquidity)1
A collection of 40-Act registered mutual funds designed to provide uncorrelated returns through daily liquid vehicles. Representative strategies include quantitative long/short equity, trend-following managed futures, and gold. The unifying characteristic is that these strategies tend to behave independently of broad public-market beta, while remaining fully redeemable on any business day.
2. Alternative fixed income (monthly & quarterly liquidity)2
A collection of interval funds offering exposure to areas of private credit — direct lending, collateralized loan obligations, asset-backed lending, and other more specialized sub-sectors — with monthly or quarterly redemption windows. These strategies are designed to produce income that is meaningfully higher than what is currently available from investment-grade public fixed income, while accepting more limited liquidity in exchange.
3. Private alternatives (illiquid)3
Limited Partnership structures that call and distribute capital over time, with fund terms generally ranging from five to ten years. Categories include private equity, private credit, real estate equity, real estate debt, and real assets. Illiquidity is a feature, not a bug: the term structure of the capital is what allows the manager to underwrite at a different time horizon than public markets reward, and historically that patience has earned a premium.
The diversification benefit, quantified
The reason these three categories belong together in the same conversation is that they behave independently — not just from stocks and bonds, but from each other. Drawing on industry data for representative composites in each category, the historical correlation profile across recent trailing periods looks like this:
| Average correlation, alternatives composite to… | Coefficient |
|---|---|
| Stocks (S&P 500) | +0.055 |
| Bonds (Bloomberg Aggregate) | −0.066 |
| Other alternatives composites | +0.011 |
Near-zero correlation across all three relationships is the unusual finding. Most asset classes correlate to at least one traditional benchmark; many correlate to several. A sleeve of strategies that is essentially uncorrelated to stocks, to bonds, and to itself is what gives a portfolio the structural diversification that the simple 60/40 can no longer consistently deliver on its own.
The efficient frontier, with and without alternatives
The efficient frontier represents the maximum potential return achievable at every possible level of portfolio risk. In practice, a real client portfolio is constructed using expected returns, not realized ones — but for illustration, consider what happens when we use trailing five-year returns to construct two efficient frontiers: one limited to the S&P 500 and the Bloomberg Aggregate Bond Index (two assets), and another that adds the three alternatives composites (five assets).
At a target standard deviation of six percent — a level of risk consistent with what many investors would consider conservative — the optimally allocated five-asset portfolio produced an annualized return of approximately 12.1%. The optimally allocated stock-and-bond portfolio at the same risk level produced an annualized return of approximately −0.1%. To reach a comparable 12% annual return using only stocks and bonds, an investor would have needed to accept a standard deviation closer to 14.5% — more than twice the risk.
The lesson is not that alternatives guarantee outperformance — they do not, and any manager who promises otherwise should be heard with care. The lesson is geometric. Adding return streams that are genuinely uncorrelated to existing ones expands the set of portfolios available on the frontier, particularly in the lower-volatility region where clients with meaningful balance sheets and ongoing liquidity needs spend most of their time.
Where this could be wrong
Three legitimate counter-arguments deserve to be addressed.
First, correlations are not constants. The negative stock-bond correlation that prevailed for two decades has reverted; the near-zero correlations cited above could equally migrate toward one in a sufficiently severe risk-off event. Diversification is most valuable when it is least reliable, and that is an uncomfortable truth that no amount of historical data will resolve.
Second, alternatives carry costs — in fees, in operational complexity, in due diligence demands, and in the cognitive load of explaining illiquid positions to clients during drawdowns. Those costs are real and they compound. An alternatives sleeve that is not large enough to materially affect portfolio outcomes is an alternatives sleeve that should not exist.
Third, manager dispersion in alternatives is dramatically wider than in public markets. The gap between top-quartile and bottom-quartile private equity managers, for instance, is an order of magnitude larger than the equivalent gap in long-only large-cap equity. Average exposure to alternatives is a categorically different proposition than thoughtfully selected exposure to them. The work is in the selection.
What this means for portfolios
The 60/40 portfolio is not broken — but it is no longer the only sensible answer to the question Markowitz set out to solve. For households with the patience to accept some illiquidity, the operational capacity to hold private structures, and the discipline to size positions thoughtfully, a well-constructed allocation to alternatives now belongs in the same conversation as stocks and bonds when defining a durable portfolio.
At Highbrook, alternatives are not a sleeve we add for product completeness. They are a deliberate, sized response to the structural changes in the correlation environment of the last several years — and to the conviction, supported by the efficient frontier, that the right combination of uncorrelated return streams remains the most powerful tool a long-term investor has.
Notes. 1 Liquid alternatives composite reflects a representative static allocation to a preferred mix of strategies using publicly available monthly return data. 2 Alternative fixed income composite reflects a representative static allocation using publicly available monthly return data; Cliffwater Direct Lending Index returns used for months prior to 5/31/2019. 3 Private alternatives composite reflects industry-standard category benchmarks for the relevant fund vintages. Past performance is not indicative of future results. Correlation and return figures are based on trailing periods and are subject to change. All data as of recent publicly available periods unless otherwise noted.