Beyond the 60/40 portfolio: private capital's power of diversification

One of the main advantages of investing in private capital is the diversification provided to portfolios.

In this post we explain what diversification is and why including this type of investment in a traditional fixed-income and equity portfolio can increase your portfolio's profitability, while reducing volatility.

Divide and conquer. To control the risk and volatility of our portfolio, it is advisable not to bet everything on one and invest in assets with different characteristics, this practice is called diversification. With the expression “don't put all your eggs in one basket”, we summarize very well what diversification is and how important it is in the field of savings and investment.

There are many ways of doing this, for example, by investing in different geographies, sectors or terms, but one of the most important is through the combination of different types of investments, for example, combining investment in traditional assets (fixed income and equities) with investment in private equity.

The main characteristic of private equity investment is the decorrelation it brings to the portfolio. This means that, for example, when there is an event that impacts the public markets, it will be more difficult for your private equity investments to become contagious, so you will have a good hedge against these events.

In the long term, in various market conditions, including private capital investment has proven its capacity to improve the risk-return ratio versus traditional fixed-income and equity portfolios. But, an image is worth more than a thousand words: see for yourself in the chart below.

Source: J.P. Morgan Asset Management, 2022, Know your Alternatives
Note: alternative assets include Hedge Funds, Real Estate and Private Equity, each with the same weighting. The portfolios are rebalanced on an annual basis. These data are based on the balancing at May 2022.

Let's see the various scenarios they show:

• If we modify the first portfolio in which equity represents 40% and fixed income 60% (down to the left), giving alternative assets a weighting of 30%, fixed income 40% and equity 30%, we see how volatility is reduced (the sector moves to the left) and profitability increases (the sector moves upwards).
• SIf the portfolio in which equity represents 60% and fixed income 40% we add alternative assets (30%) and reduce the equity to 40% and the fixed income to 30%, we see again how volatility drops while the profitability rises.
• Lastly, if we add 30% of alternative assets to a portfolio in which equity represents 80% and fixed income 20%, reducing equity to 50% and fixed income to 20%, we will obtain the same result: less volatility and greater profitability.

In this example, we always give alternative assets a weighting of 30% in our portfolio. However, each investor must set the degree of prominence that best fits their profile based on their objectives and needs. Assigning greater or lesser weight will depend on aspects such as your time horizon, your objectives or your tolerance to the lower liquidity of these assets compared to traditional investments.

In addition, the diversification provided by alternatives assets in portfolios can also be sought in the universe of private capital, where each type of asset offers its own characteristics that are complementary with respect to each other. There are assets within the scope of private capital that help reduce your portfolio's risk; others, for example, reduce volatility.

However, as with all investments, it entails risks, so investors must invest considering their assets, financial knowledge, investment horizon and risk tolerance.

In this Learn and Grow masterclass, you can learn more about diversification in private markets. 

This content is purely informative. It is a financial training content that Crescenta makes available to you, with no intention of issuing any type of personalized investment recommendation.

It is not in any case an advertisement of any type of financial instrument, nor a recommendation or offer to buy.

Author

Sofía Cisneros

Communication and content - Crescenta