Private market assets are projected to grow at more than twice the rate of public assets, reaching $60 trillion to $65 trillion by 2032.¹ This anticipated expansion underscores investors' search for portfolio diversification, across all diversifiers like private equity, private credit, broad commodities, real estate, infrastructure and gold. Academic research consistently demonstrates that such diversification enhances a portfolio's risk/return profile. And such diversification is particularly pertinent now given the rising concentration in market cap-weighted indexes, where a handful of large tech companies dominate, thereby reducing diversification within these core portfolio components. However, achieving this additional diversification presents a significant challenge: how to incorporate these assets while maintaining exposure to core holdings like public equities and fixed income.

The Diversification Dilemma: Finding the space for More and More Diversifiers

In recent years, WisdomTree has conducted extensive research on enhancing portfolios through alternative assets and diversifiers to improve overall long-term efficiency. Our analyses, both retrospective and prospective, indicate that:

• Broad commodities could warrant an allocation of up to 15% in a multi-asset allocation (Shah & Debru, "The Case for Investing in Broad Commodities"), (Shah & Berlanda, "The Role of Broad Commodities in a Portfolio," September 2023).
• Most portfolios would benefit from a gold allocation of up to 10% or 15% (Shah & Berlanda, "The Role of Gold in a Portfolio," October 2023).

Collectively, these assets could constitute 20% of a portfolio. Employing a delta-one approach would necessitate a substantial reduction in allocations to bonds and, predominantly, equities to accommodate these diversifiers. Clearly, investors require innovative tools to address this issue and unlock new opportunities for their portfolios.

Introducing Efficient Core: A New Era of Smart Investing

To tackle this challenge, WisdomTree has developed a range of Efficient Core strategies designed to enhance capital efficiency by stacking multiple assets within a single solution. This framework is very flexible, allowing us to provide a 90% exposure to large-cap equities and a 60% exposure to U.S. Treasury bonds for every $100 invested. Or to stack 90% of gold futures contracts on top of a 90% allocation to large-cap equities.

The WisdomTree U.S. Efficient Core Fund (NTSX), WisdomTree International Efficient Core Fund (NTSI) and WisdomTree Emerging Markets Efficient Core Fund (NTSE) are comprised of three key exposures:

• Equity Exposure: 90% invested in a diversified basket of large-cap stocks in the relevant geography
• Bond Exposure: 60% in a diversified basket of U.S. Treasury bond future contracts, ranging from 2- to 30-year maturities
• Cash Collateral: 10% cash, serving as collateral for futures contracts

Effectively, this approach delivers a capital-efficient 60/40 allocation, freeing up capital that can be allocated to diversifying assets without sacrificing core equity and bond exposures.

The WisdomTree Efficient Gold Plus Equity Strategy Fund (GDE) also has three key exposures:

• Equity Exposure: 90% invested in a diversified basket of U.S. large-cap stocks
• Gold Exposure: 90% in gold futures contracts
• Cash Collateral: 10% cash, serving as collateral for futures contracts

Effectively, this approach allows the creation of a gold exposure in the portfolio without having to reduce the allocation to other risk assets such as gold.

Capital Efficiency in Portfolios: Making Room for Alts/Diversifiers

By using the Efficient Core strategy, investors can maintain their desired exposure to traditional assets while freeing up capital to invest in diversifiers such as gold, private assets or broad commodities. This methodology facilitates the integration of alternative investments aimed at enhancing diversification and potential returns without compromising the foundational holdings of the portfolio. Additionally, it allows for the introduction of uncorrelated return streams, improved diversification, reduced portfolio volatility and more consistent performance across various market conditions.

Consider a practical example: starting with a 60/40 portfolio investing in global equities and U.S. Treasuries. Traditionally, incorporating commodities, gold or real estate would require reducing the equity allocation, as these diversifiers tend to exhibit volatility. However, by allocating 66.7% of the capital to Efficient Core Funds, an investor would achieve a 60% exposure to global equities, a 35% exposure to fixed income (via U.S. Treasury futures contracts) and 8% exposure to gold. This allocation leaves 28.3% of the capital available for investment in alternative assets and diversifiers of the investor's choice once 5% of U.S. Treasuries have been added to complete the 60/40.

Figure 1: Using the Efficient Core Strategy Creates Space for Both the 60/40 Exposure and Multiple Diversifiers

For illustration only.

Conclusion

Diversification is increasingly becoming a key driver of portfolio construction. With correlations rising within and across asset classes, it is imperative for investors to explore beyond core assets and consider new asset classes that are becoming more accessible. Conversely, creating space in the portfolio for these diversifiers must not come at the expense of the portfolio's long-term return potential. The Efficient Core strategies provide a viable pathway to achieve this balance, enabling portfolios to be both diversified and positioned for long-term growth.

¹ Source: Bain & Company. August 2024. https://www.bain.com/about/media-center/press-releases/2024/private-market-assets-to-grow-at-more-than-twice-the-rate-of-public-assets-reaching-up-to-%2465-trillion-by-2032-bain--company-finds/?utm_source=chatgpt.com