an all-weather portfolio should help with diversification all of the time

Contrary to the old adage, when it comes to investing, desperate times do not necessarily call for desperate measures. In fact, far from it. Ensuring that a portfolio is sensibly allocated and diversified should help to mitigate the adverse effects of political or economic shocks such that the knee-jerk reaction to get out of the market can be resisted: an ‘All-Weather’ strategy.

​When constructing multi-asset portfolios for DFMs and advisory firms, our process at Elston begins with four primary categories: equities, fixed income, cash & equivalents, and alternatives. We classify any investment that falls outside the first three groups as an alternative. The fundamental motivation for including this category is diversification so it is essential that we verify that the holdings in question are actually fulfilling that role.

Defining the alternatives space for All-Weather investors

​Historically, property has been the dominant choice for advisory firms seeking alternative exposure. This often comes about because of the way in which it fits specific risk profiling or asset allocation models used. Unfortunately, these frameworks are in many cases restricted in terms of the number of distinct asset types they can effectively model, so the full breadth of opportunity is missed.
 
To drill down, we would start by dividing the alternatives universe into two distinct categories:

1. Alternative assets (“Different Things”): This includes tangible or specialized exposures like infrastructure, gold, commodities, and property. We make a clear distinction between physical property and property securities. While they share similar economic drivers over the long term, they offer different trade-offs regarding liquidity and reported volatility—the latter often being a result of how frequently they are valued.
2. Alternative strategies (“Doing Things Differently”): This refers to investment methods rather than just the underlying assets. Absolute return funds, for instance, might hold traditional stocks or bonds but apply risk management overlays to target a specific performance hurdle and mitigate losses. Risk-weighted and long-short equity models also sit within this bracket.

Essential factors for sizing an allocation

When building an alternatives allocation to sit alongside the broader All-Weather portfolio, three criteria are vital:

• Return contribution: ideally, these holdings should offer returns that meet or exceed the performance of the equity, bond, and cash mix for a given risk level.
• Risk contribution: the volatility added by these assets should ideally be comparable to, or lower than, the rest of the portfolio.
• Correlation structure: this is perhaps the most critical yet complex metric. If a selection of "alternative" holdings behaves exactly like the equity or bond components during a market shift, they offer diversification in name only. For true benefit, they must exhibit low or zero correlation with traditional assets. Modern portfolio theory shows that integrating uncorrelated assets allows the total portfolio risk to be lower than the sum of its individual parts—the classic "free lunch" of investing.

An adaptive strategy

Because we define our multi-asset models by their equity risk, we place Alternatives within the “non-equity” portion of the strategy. Investment approaches vary; some managers avoid Alternatives entirely, which proved challenging during the decade of near-zero interest rates when bonds struggled. Others maintain fixed weightings, which suits a static strategic view. However, we prefer an adaptive model that shifts the balance between Bonds and Alternatives based on the prevailing outlook for inflation and interest rates.
 
When rates and inflation are climbing, tilting toward Alternatives as part of an All-Weather strategy is prudent. As inflation cools and interest rates begin to pivot, increasing the bond weighting at the expense of Alternatives often becomes more attractive. Ultimately, the specific mix within the Alternatives sleeve remains flexible, guided by expected returns, risk, and - most importantly - how well those assets decouple from the rest of the market.