| "Investors are increasingly exploring a broader range of approaches that can provide differentiated sources of return and diversification, improve portfolio robustness and reduce dependence on traditional market beta." |  |
Why investors are rethinking portfolio construction
For decades, portfolio construction was built around a simple idea: equities drive long-term growth while government bonds provide diversification during periods of market stress. Recent years have challenged that assumption. Inflation shocks have demonstrated that equities and bonds can fall together, exposing the risks of relying on a single source of diversification.
As investors adapt to this new environment, attention is increasingly shifting towards a total portfolio approach (TPA). Rather than allocating capital according to traditional asset class buckets, a total portfolio approach assesses investments based on how they contribute to overall portfolio objectives, whether by enhancing return potential, improving resilience, or strengthening diversification.
This paper explores five investment strategies that we believe deserve greater attention from investors seeking alternative sources of diversification:
- Absolute return bonds
- Currency alpha
- Protected equity
- Short-duration fixed income
- Commodities
Together, these strategies may help investors diversify across a broader range of return drivers, reduce reliance on traditional market beta and improve portfolio resilience.
Key insights from the paper
1. Absolute return bonds: Seeking returns independent of market direction
Absolute return bond strategies are designed to target positive returns regardless of broader market movements. Unlike traditional bond portfolios that derive most returns from market beta, these strategies aim to generate returns through multiple independent sources including duration, yield curves, inflation, currencies and relative value opportunities.
2. Currency alpha: An alternative source of return and diversification
Currency markets represent one of the deepest and most liquid markets in the world, yet many investors remain underexposed to their diversification potential. The paper highlights how currency alpha strategies can generate returns from multiple drivers including carry, momentum, value, volatility, quality and macroeconomic fundamentals. By combining these independent return sources, investors may gain access to a return stream that has historically exhibited low correlation with both equity and fixed income markets.
3. Protected equity: Maintaining growth potential while reducing drawdowns
Equities remain one of the most effective engines of long-term wealth creation. However, significant market drawdowns can have lasting impacts on portfolio outcomes. Protected equity strategies seek to address this challenge by combining long-term equity exposure with multiple layers of downside protection. The goal is to reduce drawdowns during market declines while continuing to participate in a significant proportion of long-term market upside.
4. Short-duration fixed income: Building resilience through income
In today's environment of persistent uncertainty, elevated government debt levels and fluctuating interest rate expectations, short-duration fixed income strategies can provide an attractive balance between income generation and risk management.
The paper examines four areas of opportunity:
- Global short-dated investment grade credit
- Global short-dated high yield
- Floating-rate credit
- Asset-backed securities
5. Commodities: A natural diversifier and inflation hedge
Commodities can possess characteristics that may make them valuable portfolio diversifiers, particularly during inflationary periods. Historically, commodities have demonstrated links to economic growth and inflation while maintaining relatively low correlations with traditional financial assets. As inputs into global production and consumption, commodity prices often respond differently to economic and market developments than equities and bonds. At times when inflation challenges both bond and equity markets, commodities may help strengthen portfolio resilience.
Bringing strategies together in a total portfolio approach
A total portfolio approach seeks to combine complementary strategies that respond differently to economic and market environments. By incorporating exposures such as currency alpha, commodities, absolute return bonds, protected equity and short-duration credit, investors may be able to build portfolios that are less dependent on any single source of return.
The paper highlights how combining alternative return sources can potentially:
- Improve diversification
- Reduce portfolio drawdowns
- Enhance risk-adjusted returns
- Improve recovery following market shocks
- Strengthen long-term investment outcomes
Download the paper
Read a total portfolio approach: the hunt for alternative sources of diversification to explore how a total portfolio approach can help investors identify alternative sources of diversification, improve portfolio resilience and position portfolios for a wider range of future market outcomes.
