When news flow is fast-changing and markets become choppier, it is easy to focus portfolios exclusively on near-term risks and opportunities.
Geopolitical tensions, technological disruption, and changing monetary policy expectations have injected more volatility into markets.
But short-term noise should not obscure long-term investment plans. We still believe alternative investments are vital tools to provide genuinely diversified sources of return and support steadier, more robust portfolios.
Hedge funds can take advantage of the current ‘stock pickers’ market’
Hedge funds pool investor capital and use flexible mandates to invest across assets such as equities, bonds, commodities, and derivatives. Unlike traditional mutual funds, they may take both long and short positions and use strategies designed to capture opportunities in rising, falling, or dislocated markets.
Their potential value extends beyond headline returns. Hedge funds can seek “alpha” by exploiting mispricing, corporate events, differences between related securities, or global economic trends.
We continue to favor discretionary managers given their flexibility to adapt positioning around policy and geopolitical shifts.
We also see ongoing opportunities for equity market neutral and multi-strategy funds, which can generate returns in both rising and falling markets as they flexibly position around economic developments. Equity hedge was the top first-half strategy, returning +9.5% based on HFRI data, supported by elevated stock dispersion and greater opportunities for security selection.
Their return patterns may also have weaker relationships with traditional equities and bonds, potentially helping to diversify portfolios and limit drawdowns. CIO analysis of data from 1997 to 2024 illustrates the potential portfolio effect: Adding 20% hedge funds to a portfolio initially comprising 50% equities and 50% bonds could have increased annualized returns from 5.7% to 5.9%, and reduced volatility from 9.2% to 8.5%.
Ways to invest include single-strategy hedge funds that focus on one specific investment approach, multi-strategy funds that engage in multiple strategies under one umbrella, and fund of hedge funds (FoHF) that invest in a collection of hedge funds, providing diversification across various styles and sub-strategies.
For first-time investors, a sensible starting point is an investment plan aligned with objectives, risk tolerance, and liquidity needs. A typical allocation may be 8-12% of an overall portfolio, divided between “core” strategies aimed at diversification and “satellites” targeting specific objectives. Investors should assess managers, fees, transparency, leverage, lockups, and operational controls before investing. Single-strategy, multi-strategy, and fund-of-hedge-fund structures offer different levels of diversification and complexity.
Private markets: Long-term conviction but be selective
Private markets can provide access to companies, infrastructure, and strategies unavailable through public markets. Their long-term orientation may help investors participate in structural opportunities linked to artificial intelligence, energy security, and deglobalization.
Across a full economic cycle, we expect private assets to deliver returns that on average are 1 to 2 percentage points higher than public markets. These higher returns are compensation for unique risks including illiquidity, complexity, less predictable cash flows, and a longer path to value realization.
Recent challenges—including harder conditions for private equity managers to sell investments and a less compelling near-term risk-return outlook in private debt—make selectivity more important.
In private equity, the recovery from 2025 is gaining traction, but higher interest rates and greater competition mean manager selection, operational value creation and discipline matter.
In private debt, direct lending remains relevant, but tight spreads and normalizing defaults warrant caution.
In real estate and infrastructure, investors should prioritize visible income, resilient cash flows, disciplined interest-rate management, and existing assets over development projects, where appropriate.
Practical steps for first-time investors include pacing commitments, diversifying across strategies, sectors, regions, managers, and vintages, and retaining sufficient liquidity for capital calls and other needs.
