Why Diversification Matters More Than Ever
Harry Markowitz, the inventor of modern portfolio theory, famously described diversification as ‘the only free lunch in investing’. Until now, many investors have sought diversification by investing in an index such as the S&P 500, and by maintaining a substantial portion of their portfolio in bonds as a hedge against market volatility.
The S&P 500 has become drastically more top-heavy in recent years. Some estimate that it has never been more concentrated than it is now.[2]
The top ten members of the S&P 500 now account for around 37% of the index. This makes the returns of the index vulnerable to volatility. If the performance of even only the top seven companies were to decline (for example, owing to greater regulatory scrutiny), returns to the index would be disproportionately impacted.
As we move into 2025, there is considerable uncertainty concerning US policies on immigration and tariffs, in addition to geopolitical tensions and the fragmentation of trade.[3]
This combined with concerns over government debt and the specter of stubborn or resurgent inflation means that while traditional assets like public equities and bonds remain core components of many portfolios, their limitations in today’s environment underscore the need to incorporate alternatives to achieve broader diversification and resilience.
The Role of Alternatives
Alternatives offer potential opportunities for higher enhanced returns than traditional investments. Particularly, in times like these, they also provide an additional layer of diversification.
Low Correlation
Harvard Business School defines alternatives as investments that are not easily sold or quickly converted into cash, unlike traditional investments. While alternatives are relatively illiquid, this longer holding period can shield them from short-term market volatility, allowing investors to take a more strategic, long-term approach to their portfolios.
By virtue of this fact, alternative asset prices are shielded from radical shifts in market sentiment, which can place downward pressure on all stocks in an index, regardless of underlying fundamentals.
Higher Agility
While index investing works well during a time of stable growth, volatility requires a more precise and flexible approach, targeting areas of growth and stability. By focusing on specific sub-sectors and companies, whether investing in debt or equity, alternatives provide a means of side-stepping general market malaise.
For example, while trade disruption may be a net negative for the global economy and public markets in the short term, the reconfiguring of supply chains creates ample opportunities for investing outside the stock market (e.g. new storage and manufacturing facilities).[4]
Inflation Hedging
While inflation can have a negative impact on both stocks and bonds, many alternatives can counter the effects of rising prices. For example, real assets, particularly those in areas of inelastic demand such as healthcare, data centers, or critical infrastructure, provide stable income via contracted revenues that are often inflation-protected.
Secular trends such as AI adoption, renewable energy growth, electrified transportation, and demographic-driven needs such as multi-family housing and healthcare, often have the backing of the governments of the country in which they are being built.
Conclusion
Alternatives are a way to adapt to an era of heightened volatility. The fact that they are relatively illiquid and require more effort to locate and appraise is the main reason that many investors have been unwilling or unable to make full use of them in times past.
At the Family Office, we have made it our aim to bring the power of alternative assets within reach for a larger body of investors. By relying on our team’s ability to source and vet appropriate deals, our clients can approach the new year with greater confidence. No matter what the news brings, there is always a path to growth.