The great portfolio rebalancing: a shift in diversification

February 2026  |  FEATURE | FINANCE & INVESTMENT

Financier Worldwide Magazine

February 2026 Issue

Given the rampant economic and geopolitical uncertainty experienced in recent years, many investors are being urged to move away from the old normal of 60/40 investing and instead seek maximum portfolio diversification.

Today, diversification is a cornerstone of effective portfolio management, serving as a key strategy for balancing risk and reward. By spreading investments across a broad range of asset classes, investors can reduce their exposure to any single market or sector, helping to limit volatility and protect against downturns. A well-diversified portfolio seeks to smooth performance over time, ensuring that losses in one area can be offset by gains in another. Ultimately, this approach is designed to support more stable, long-term returns while minimising overall investment risk.

Diversification has perhaps never been more relevant given the state of the global economy. Against a backdrop of persistent inflation and rising interest rates, traditional portfolio diversification has been redefined over the last few years. The inverse relationship between stocks and bonds has broken down and, as a result, investors have begun searching for new anchors in a world defined by almost perpetual volatility.

The 60/40 question

Since the 1960s, the 60/40 portfolio strategy – 60 percent in stocks and 40 percent in bonds – has been the foundation of investing. According to the Center for Research in Security Prices (CRSP), few innovations have created more wealth. Over its 80-year lifespan, it has delivered annual returns of about 9 percent, turning initial investments into roughly 1000 times their original value. Since 1975, it has recorded only two years of double-digit losses (2008 and 2022), typically performing with half the volatility of an all-equity portfolio.

The model is widely considered a ‘balanced’ starting point, with allocations adjusted for time horizon, risk tolerance and goals. Its simplicity and historical resilience made it a benchmark for decades.

However, its relevance is now under scrutiny. Institutional investors are pivoting toward alternatives such as private credit, infrastructure and commodities to hedge volatility and enhance returns. This shift reflects a broader move toward resilience, inflation protection and exposure to macroeconomic tailwinds.

Warnings about the decline of 60/40 are not new, but recent years have been particularly challenging. In 2022, inflation surged to multi-decade highs post-COVID-19, and equities and bonds fell sharply together – their first major joint drawdown in nearly half a century. Rising interest rates created a positive correlation between the asset classes, and the portfolio declined roughly 16 percent, its worst performance since 1937. Although it rebounded with a 17.2 percent gain in 2024, confidence has eroded.

As a result, investors are urged to diversify beyond the traditional mix. Instead of allocating 60 percent to stocks and 40 percent to bonds, many professionals advocate broader exposure to hedge funds, commodities, private equity and inflation-protected assets. Some propose variations such as 50/30/20 – equities, bonds and alternatives respectively – to build portfolios that are more resilient in an era of structural volatility and tightening monetary policy.

The 60/40 model remains a useful reference point, but its limitations in today’s environment are clear. Investors are increasingly embracing adaptive strategies that incorporate real assets and alternative investments to achieve stability and growth across a wider range of market conditions.

A new regime

Given the difficulties encountered by the 60/40 portfolio and the prevailing economic winds, there are calls for investors to embrace a new regime for investing. Perhaps the most visible manifestation of this is the dramatic rise of alternatives. Private credit, infrastructure and commodities have moved from the fringes to the forefront of institutional strategy. According to Preqin, global private credit assets are projected to exceed $2.5 trillion by 2027, up from less than $1 trillion a decade ago.

Likewise, infrastructure funds are scaling to unprecedented sizes, buoyed by fiscal stimulus and the wider energy transition. Commodities, once considered a tactical inflation hedge, are being integrated into core allocations for their diversification benefits. Commodities – from energy and metals to agricultural products – offer both inflation sensitivity and exposure to structural demand trends such as electrification and food security. These changes are particularly notable as a structural reconfiguration of institutional capital deployment, rather than a temporary reaction to inflationary pressures.

As investors have begun to rethink their portfolio allocations, non-traditional approaches and exposures have become increasingly popular, with liquid alternatives, digital assets, income strategies and international equities helping to improve portfolio diversification.

Against the backdrop of economic and geopolitical uncertainty which has emerged in recent years, there are several options available to investors. Notably, BlackRock has suggested that investors: (i) consider liquid alternatives and gold – whether funded from fixed income or equities – to seek improved diversification and complement core building blocks; (ii) seek differentiated drivers of returns, such as macro hedge fund strategies and digital assets; (iii) look toward non-dollar asset exposures, such as unhedged international equities, which can benefit from a new foreign exchange regime; and (iv) consider equity income as an alternative to nominal fixed income exposure as an inflation-aware source of income and diversification.

The shift to a world of higher overall interest rate volatility amid greater macroeconomic, policy and market uncertainty is allowing a range of alternative strategies to gain traction, reflecting a broader shift toward diversification beyond public markets. One notable trend is the incorporation of alternative assets such as private credit, infrastructure, real estate and hedge fund strategies, which offer potential for enhanced yield and reduced reliance on fixed income.

Private credit has had a particularly important evolution in recent years. As banks have retrenched under tighter regulation and higher capital costs, non-bank lenders have stepped into the void, providing flexible financing to middle-market and corporate borrowers. For investors, the asset class offers attractive yields, tighter covenants and greater control over risk than traditional credit markets.

Risk parity and hierarchical risk parity models are also becoming more popular, focusing on balancing portfolio risk rather than capital allocation to achieve greater resilience across market cycles. Meanwhile, tactical or dynamic asset allocation approaches allow managers to adjust exposures in response to changing valuations, macroeconomic conditions and momentum signals. Hard assets such as commodities and gold are increasingly viewed as viable substitutes for traditional bonds, particularly as inflation hedges.

These developments highlight an industry-wide move toward more flexible and data-driven portfolio construction, with an emphasis on risk management, inflation protection and liquidity optimisation. While the 60/40 framework remains a useful reference point, its limitations in a regime of structural volatility are prompting investors to build more adaptive, multi-asset portfolios designed to perform across a wider range of market environments.

Alternative strategies often included in different, more diverse portfolios encompass approaches such as long or short and market-neutral investing. These strategies can provide distinct advantages compared to traditional allocations in stocks, bonds and cash, including the potential for higher expected returns, lower correlations and volatility relative to conventional markets. They also provide opportunities to exploit market inefficiencies through skill-based management.

In a similar vein, investor interest in digital currencies has accelerated over the last few years, particularly following the introduction of physically backed exchange-traded products, whether tied to assets like gold bars or to cryptocurrencies. A recurring question is what role bitcoin should play within portfolios, given its pronounced volatility and unique characteristics. Due to its high volatility, bitcoin should be viewed as a ‘risky’ asset on its own. However, the sources of bitcoin’s risk and return potential differ markedly from those of traditional risk assets, highlighting its compelling potential as a distinctive tool for portfolio diversification.

Catastrophe bonds have also emerged as a convincing diversification tool in multi-asset portfolios, especially for portfolio managers seeking exposures that are uncorrelated with the standard equity/bond risk set. The recent performance has been strong, providing double-digit returns to the end of August 2025, and over 50 percent over five years in some indices.

According to Moody’s, catastrophe bond issuance has grown markedly and was poised to set a new record in 2025. As of 28 August 2025, the market had seen approximately $18.4bn in catastrophe bond issuance from 87 transactions, already surpassing the previous annual high of $17.7bn set in 2024. Moody’s projected that total issuance could exceed $20bn by the end of 2025, given the volume of deals typically completed in the final months of the year.

Much of the growth in the catastrophe bond space can be attributed to strong demand from sponsors seeking risk transfer capacity, as well as investors attracted by risk-adjusted returns. While catastrophe bonds do come with distinct risks and structural features that require careful understanding, they are an increasingly attractive proposition, particularly in the post-COVID-19 landscape. The pandemic, which was the source of great volatility across markets, highlighted the non-correlated nature of natural disaster risks with economic cycles, further solidifying the perception and attractiveness of catastrophe bonds as an effective portfolio diversifier.

However, with catastrophe bonds, there are still some drawbacks. The question of access in particular is a challenge, with many catastrophe bond opportunities historically only available to institutional or alternative-asset investors. Though this has improved in recent years with retail access becoming more widespread, there may still be limitations depending on jurisdiction.

Geopolitical considerations

As investors continue to look for alternative portfolios, they must be mindful of geopolitical shifts and fiscal dynamics, which are increasingly reshaping how capital flows and how investors build portfolios today.

The second Trump administration and its economic policies have undoubtedly impacted global markets. Additionally, geopolitical evolution and technological platform shifts have influenced the economic environment. However, other factors have changed portfolio construction. Wider issues such as industrial policy, deglobalisation and reshoring are emerging as driving factors in the investment space.

Likewise, regulatory shifts in recent years, such as the US Inflation Reduction Act and Europe’s Green Deal Industrial Plan, as well as myriad regional supply chain incentives, have served to redirect capital flows toward sectors including infrastructure, clean energy and advanced manufacturing.

Emerging markets too represent a strategic diversification opportunity, particularly with respect to commodities and demographics. To that end, portfolio construction and diversification require investors to prioritise geopolitical insights, policy alignment and supply chain geography.

Adapting to a new investment era

Historically speaking, the 60/40 model has been a roaring success. It delivered strong, stable and competitive long-term returns with moderate risk and lower volatility. However, recent market conditions, particularly the turbulence seen in financial markets over the past few decades, have prompted calls for broader asset allocation to pursue long-term growth while maintaining a reasonable level of risk.

Arguably, the 60/40 model was a product of its time. Yet the economic and geopolitical landscape that shaped its success is no longer viable. While the strategy retains some relevance, the world is changing rapidly. Investors must now embrace flexibility, real assets and active risk management. The future of portfolio construction lies in adaptive, multi-asset strategies that integrate alternatives, technology-driven insights and dynamic allocation – enabling resilience in an era defined by structural volatility and global uncertainty.

© Financier Worldwide

BY

Richard Summerfield