Diversifying Beyond the 60/40 Portfolio: Part 2
March 20, 2023 | Larry Swedroe | WealthManagement.com
In the first article in this series, I established that portfolios should be highly diversified based on risk and that traditional 60% stock/40% bond portfolios fall short because they’re dominated by a single risk: the market. I then discussed one method of diversification, the 1/N strategy, why it’s effective and how advisors can easily help their clients implement a 1/N-like portfolio. In this installment, we’ll take a look at incorporating alternative investments.
In addition to adding factor risks across asset classes through the largest long-short multifactor, multiasset class fund of AQR, the SEC’s approval of interval funds (funds that provide limited quarterly liquidity, typically a minimum of 5% per quarter and 20% per year), allows investors to access other unique sources of risk (with historically very low correlations to stocks and bonds) that were previously only available in private (and more expensive) vehicles such as hedge funds.
Among these unique sources of risk are reinsurance, consumer and small business lending and private credit to middle-market firms (which is also floating rate debt, minimizing interest rate/inflation risk). The largest reinsurance interval fund is Stone Ridge’s SRRIX; the largest consumer/small business lending fund is Stone Ridge’s LENDX, and the largest private credit interval fund is Cliffwater’s CCLFX. Again, because it is important to show the implementation costs of any investment strategy, our starting point is June 2019, the inception date of CCLFX, and runs through year-end 2022, a total of 43 months. We will show how adding these funds to a traditional 60/40 portfolio impacts its risk and return. While the period is relatively short, it does include bull and bear markets for both stocks and bonds.
