The 60/40 portfolio is one of the most famous allocations in finance. Sixty percent equities for growth, forty percent bonds for ballast. For decades, it delivered, in large part because one crucial assumption held true: when stocks fell, bonds rose. 

That assumption has been tested as of late, painfully in some stretches, like 2022. Both asset classes suffered significant losses simultaneously, and it wasn't really an anomaly. A whole generation of investors just hadn’t seen or lived through anything like that before. Just like a global pandemic, it was a shock, as was the subsequent rapid monetary tightening cycle. Fast forward to today, and there are still big open questions on the macro front that we think could have important implications for markets, and specifically the relationship between stocks and bonds. Our research shows that when core inflation persists above roughly 2.5% on average, the correlation between equities and bonds has historically turned positive. Stocks and bonds start moving together and the diversification that 60/40 depends on can feel scarce right when you need it most. That’s exactly what we’ve witnessed since early 2021, as seen in the rising dark blue wave in Figure 1, which shows a growing and more persistent positive correlation between stocks and bonds.

Figure 1: Rolling 12-month correlation of monthly returns in stocks vs bonds

Source: Stock-bond correlation shown in rolling 12-month periods as represented by the S&P 500 Total Return and the Bloomberg Barclays US Treasury Aggregate Total Return indices. Date range: February 1992 – August 2026.

We think this positive correlation could continue as inflation remains sticky and major central banks like the Federal Reserve (Fed) are compelled to keep interest rates relatively higher and restrictive – even if growth slows or stalls and stocks slump. This gets to the main driver of why 60/40 is no longer working, in our view. For the last 20 years or so, when equities sold off investors bought bonds as a flight to safety move, which was supported by an assumption (and reality) that monetary policy would be more accommodative in times of stress (with rapid rate cuts being the most obvious stopgap). This became the ‘Fed put’, or the idea of an informal safety net from that policy support. But now, with buoyant equities and ballooning public debt alongside stubborn inflation, it looks like it might be time to pay the bills for two decades of stimulus. Continuing to push stimulus and accommodative policy is not free. What’s more, we think the ‘Fed put’ strike, or the pain point at which the Fed would step in, could be potentially shifting to a higher pain tolerance (lower strike) under the Fed’s new Chair, Kevin Warsh, who seems keen to watch market forces play out and must contend with various supply shocks and the read-through to inflation. For investors who need to stay invested, this isn't an academic exercise. It's a practical problem. If the bond allocation can't reliably cushion equity drawdowns, what can? And in what ratio?

The diversification most portfolios are missing

The instinct is to add more asset classes, like private equity, real estate, commodities and infrastructure. This sounds like diversification, but is it? Many of these ‘alternatives’ can carry more equity-like risk than you think. Private equity returns, for instance, are highly correlated with public markets once you account for valuation lags and illiquidity smoothing. REITs can behave like equities in a crisis. Commodities can be volatile and hard to implement consistently.

The real question isn't "how many asset classes do I own?" It's "how many genuinely different return drivers am I accessing?"

That distinction matters. A portfolio with six asset classes that all respond to the same macro forces, like growth and interest rates, isn't diversified. It just looks that way until markets stress-test it.

What genuinely diversifying alternatives could look like

We believe true portfolio diversification comes from accessing return streams that behave differently from your core equity and bond holdings, not just in calm markets but especially during drawdowns. That also makes liquidity an important consideration when thinking through your ‘alternatives’.  It’s worth taking a moment here to unpack that term: alternatives at their core are simply alternative investment options to traditional ones (typically stocks and bonds).

Private markets have been a major focus in the alternatives space in recent years, but alternative strategies are available through public markets as well. These ‘liquid alts’ may offer an attractive sweet spot for diversification and liquidity, in our view, and are now re-emerging as the traditional 60/40 portfolio shows some wear in the current macro environment after a long run of resilience when interest rates and inflation were relatively low. Looking back at Figure 1, you’ll see nearly two decades of negative correlation between stocks and bonds from the early 2000s through 2020. The 60/40 was thriving. Bonds were diversifying as intended, cushioning stocks when they fell. Liquid alts, meanwhile, spent less time in the sun through most of that period. It’s not hard to see why. The strategies and architecture from a portfolio construction perspective were novel and interesting and made good business sense, but the investment case when factoring in costs was harder to justify for investors. Why pay up (or at all) for diversification when you could essentially get it for free in your traditional fixed income allocation to bonds? That mood is changing now, we think, as traditional diversification is tested. We see more investors seeking liquid alts as a result. They’re now finding strategies that have grown up as well, with learnings from tougher periods now baked into investment processes (similar in a way to portable alpha, which learned some hard lessons itself from the Global Financial Crisis (GFC), and is now also re-emerging with more robust structures). Liquid alts span many strategies. Here are some that stand out to us in this market environment:

1. Trend following. These strategies go long assets moving up and short assets moving down, across dozens of liquid markets spanning equities, bonds, currencies and commodities. Because they have potential to profit from both rising and falling markets, they've historically provided positive returns during extended equity drawdowns, the exact moments when traditional diversifiers tend to fail.
2. Market-neutral relative value strategies. By going long stocks expected to outperform and shorting those expected to underperform in roughly equal measure, market-neutral strategies aim to strip out broad market exposure entirely. The goal is to generate returns from stock selection alone, with near-zero correlation to the equity market. In a market with a high degree of dispersion, relative value strategies have the opportunity to generate returns without the broader market exposure, known as ‘beta’.
3. Dynamic multi-asset approaches. Rather than holding a static mix of traditional assets, these strategies use risk signals to actively adjust exposures, reducing allocation to declining markets and increasing it to improving ones. Think of it as risk management built into the portfolio, not bolted on after the fact.
4. Long volatility. A bet on risk may be a bet against volatility.  Long volatility is a known diversifier, but it can come at a heavy cost. Until recently, many investors viewed long volatility as an insurance premium they would rather not pay as it reduces the total rate of return in the broader portfolio. More turbulent markets could be reshaping that view.

What these approaches share is a focus on how returns are generated, not just which asset class they come from. They use liquid instruments (publicly traded equities, bonds and futures) which means they're transparent and cost-effective.

What this means for portfolios

None of this means abandoning 60/40 entirely. Stocks and bonds still play essential roles. But relying on them alone to provide both growth and protection might be an unintentional bet on a macroeconomic regime that may not persist, in our view.  If we enter a stagflationary period, for example, we think bonds and equities would likely sell off together.

That’s why we believe integrating a portfolio building block of genuinely diversifying liquid alternatives could help in a few specific ways:

1. Reduce drawdown severity. When equity markets sell off, strategies with low or negative market correlation could dampen the impact on the overall portfolio.
2. Smooth the return path. For investors approaching or in retirement, sequencing risk — the danger that poorly timed drawdowns permanently impair outcomes — is a real and growing concern. A smoother return stream could potentially help protect against it.
3. Free investors to stay invested. The biggest enemy of long-term returns is panic selling. A portfolio that holds up better in stress is more likely to give investors the confidence to stay the course.

The 60/40 portfolio served a generation well. But the conditions that made it work seem to be changing. For investors building portfolios today, the question isn't whether to include alternatives; it's how to choose the right ones for the right needs.

AI was used to support data analysis and processing as well as some early drafting in the production of this article.