Solving the Investor's Dilemma

September 2025

This article appeared in the Sunday Times on 21st September 2025.

How to build a portfolio to capture equity gains but manage the downside

With equities at record highs, investors face a familiar dilemma. The long-term rewards from equities are compelling, but so too are the risks, from stretched valuations to rising debt levels. Warnings of overheating have been sounded for years, yet the market keeps grinding higher. The real danger may not be the next short-lived correction — like those in 2020, 2022 and 2025 — but a more prolonged and damaging downturn.

Is there a way of participating in the upside yet managing the downside risk?

Managing equity risk

Averaging into the market with regular investment is one approach. For regular savers or pension contributors with long time horizons this make sense. If the market rises you gain on existing holdings, if it falls you invest at more lower levels.

Somebody considering a lump sum investment could take a similar approach, spreading the investment over say a year. But that is not without risk. One could scale into a rising market but complete the investment just before the market turns down.

Diversifying across a portfolio of stocks internationally is another suggestion. US exceptionalism has translated into US outperformance in the last decade but there are signs that is changing. However historically when equity markets fall, they tend to fall in unison.

Historically, the advice was to blend equities with bonds. The 60-40 equity/bond portfolio is the industry standard in this respect. On the surface this seems sensible. Equities for growth, bonds for defence. Bonds cushioned equity falls for decades, but 2022 showed they can fall together, especially when inflation rises. There are plenty of reasons to suggest inflation could be more of a challenge for investors going forward.

The premise of many multi-asset funds is that they are more diversified and provide upside participation with less downside risk. In reality, many multi-asset funds behave just like the 60-40 portfolio. A wide range of assets—from equities to high yields bonds to emerging markets -tend to perform just like equities. They do well when the economy is solid, but in a deep recession, they typically underperform together.

Equally, many assets—from long-duration bonds to equities—do well when inflation is contained and interest rates are falling.  What about a regime of rising inflation or even stagflation (rising inflation when the economy is weak). Most portfolios are still ill-prepared for either a severe downturn or a stagflationary environment.

These concerns have fuelled an interest in more innovative solutions - particularly alternative investments

The promise and reality of alternatives

But what are alternatives, and can they really live up to the promise of offering something genuinely different?

Broadly, they come in two flavours – alternative assets and alternative strategies. Private equity, infrastructure, venture capital and private credit are in the alternative asset side. While there can be a solid case for these, they should be thought of as alternative growth strategies rather than diversifiers. In a severe downturn don’t expect them to provide much of an offset to equities.

That’s where alternative investment strategies come in. These are trading strategies that can go long or short in markets.  That gives more flexibility to respond to market moves. They can go short and profit from falling equity prices and they also often trade markets like commodities, typically underrepresented in many portfolios.

One set of alternative investments that deserves attention is systematic or rules-based strategies.

Investors might find systematic strategies intimidating, often lumping them under “quant” investing and assuming they rely on opaque, black-box algorithms. But some systematic strategies provide a disciplined rules-based alternative—removing emotional bias, sidestepping macro speculation, and dynamically adjusting to market shifts.

Systematic trend-following, for example, buys assets that are rising, sell those that are falling. That’s it. It doesn’t try to predict macro events; it simply reacts to price movements.

The really interesting and valuable aspect of alternative strategies is that some, like trend-following, have delivered strong returns during periods of major market stress such as 2022, 2008 and during the dotcom bust, making them a powerful complement to equities.

Of course, no strategy is perfect. Trend-following struggles in choppy, directionless markets, where false breakouts and sudden reversals can erode returns.

At its core, investing isn’t about eliminating uncertainty—it’s about managing it intelligently.

While equities will likely continue to deliver strong returns over the long term, the path forward will be unpredictable. In 1996 Alan Greenspan famously warned about irrational exuberance only for the market to rise for another three years before the dotcom boom turned to bust.

For investors grappling with the current investing dilemma, diversification makes sense. The next correction is inevitable — we just don’t know when. The goal isn’t to avoid risk altogether, but to build a portfolio resilient enough to withstand it. True diversification means looking beyond the traditional mix of equities and bonds and considering alternative strategies that can adapt when markets change.

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