Portfolio Construction with Alternatives

Key takeaways

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

• As capital markets evolve, the opportunity to add private market assets to traditional portfolios also grows.
• Private market investments have historically enhanced portfolio returns by offering unique opportunities as well as characteristics that complement public exposures.
• One strategy for incorporating private markets into portfolios takes the traditional 60/40 allocation to a “modernized” 50/30/20 framework.

New thinking for a new marketplace

Traditional diversified portfolios are typically anchored to broad public benchmarks. While public indexes are transparent, there are limitations from a portfolio construction perspective:

• Equity indexes are market-capitalization weighted and, as such, concentrate exposure in the largest companies and sectors.
• Bond indexes are weighted by issuer and can expose portfolios to unintended duration and credit concentration.

This means a traditional 60% equity/40% bond (60/40) portfolio can be structurally overexposed to two primary return drivers: equity beta and bond duration.

However, a wider range of investors are gaining access to a broader range of capital markets, and this translates to greater opportunity to potentially enhance portfolio outcomes by targeting new sources of risk and return.

A place for private markets

Private markets are becoming critical exposures for those looking to access a broader set of portfolio building blocks, particularly as the proportion of opportunities shift from public to private markets.

While the number of public companies has been shrinking in recent decades, the number of private companies is on the rise. In the U.S., the number of large private companies (those with 100+ employees) has grown by 46% over the past 30 years, while the number of public companies has fallen by 24%.¹ The trend is not isolated to the U.S., as research shows the number of listed companies has declined across many developed economies.

Companies are also increasingly seeking private funding, with just 25% of the leveraged loan market funded by banks in 2024 compared to 72% 30 years earlier.²

Taken together, this illustrates that modern capital formation extends beyond public exchanges, creating a larger role for private markets and allowing portfolios to participate more fully in an evolving and expanding investment landscape.

The private markets toolkit

Private equity and private credit are two of the most common private market exposures. Both have delivered higher returns than traditional asset classes over the past decade, as shown in the chart below.

An opportunity for enhanced returns: Ten-year average annual returns as of year-end 2024

Real estate and infrastructure are two other popular private asset classes. Their role in portfolios is often to provide a mix of potential capital appreciation and income, as well as an inflation hedge given that they are real assets with tangible economic value.

Returns in private markets are driven by different structural factors than public markets, which can make them compelling complements in a diversified portfolio:

• Illiquidity of underlying assets often offers a premium which can help offset potential over-indexing to more liquid structures (and associated sacrifice of return potential).
• Periodic valuation rather than continuous pricing can mean less transparency, but potentially less sensitivity to headline-related market volatility.
• Wider dispersion of outcomes across managers, making manager selection a potential differentiator.
• Varying capital commitment structures or hold periods, which also means more choice for managing around investment time horizons and goals.

From 60/40 to 50/30/20

The “optimal” allocation to private markets will depend on the individual investor’s goals and risk tolerance. For example, is the investor seeking long-term growth or income, and are they sensitive to tax considerations?

While the decision can be decidedly individual, today’s market landscape does challenge the continued applicability of a traditional 60/40 portfolio. It may mean that the definition of ‘diversification’ needs to evolve along with the investing backdrop.

A 50/30/20 framework provides one way to reflect today’s broader opportunity set:

• 50% public equities
• 30% public, fixed income
• 20% alternatives, including private markets and liquid alternatives

Effectively, this model suggests that equity exposure is moderated from 60% to 50% and fixed income is reduced from 40% to 30%, opening a 20% opportunity to add other diversified return drivers.

The funding of this new allocation will have a meaningful impact on a portfolio’s risk/return profile. Many of our BlackRock Portfolio Constructors suggest a like-for-like funding strategy wherever possible: funding strategies with equity-like risk profiles from equities and bond-like risk profiles from bonds.

Sourcing higher-risk allocations from bond sleeves can increase portfolio risk, while sourcing lower-risk allocations from stock sleeves could decrease risk and potentially also impact expected returns.

Stepping into private markets

Modern capital markets extend well beyond traditional public equity and investment-grade bond benchmarks. Private markets offer access to unique opportunities that can complement positions in traditional assets.

According to a recent BlackRock survey, wealth professionals expect allocations to private markets to increase significantly by 2030, with over 70% of wealth investors projected to allocate between 5–20% of their portfolios. This compares with today, where around two‑thirds of wealth investors are believed to allocate just 0–5% to private markets.³

Whether working toward a 20% allocation or another level better suited to client needs, we offer a four-step framework for thinking about and incorporating a private markets strategy:

1. Choose private market exposures
   Select alternative asset classes that further portfolio objectives.

2. Determine your allocation
   Decide the size of your allocation, based on risk/return assumptions and liquidity budget.

4. Choose the right investment
   Pick the right vehicle to access your target exposures.
5. Fund from “like” asset classes
   Source from traditional asset classes based on risk, return and correlations to equity.