Alternative History: Would Some Investors Have Been Better Off Not Chasing Alts?
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Alternative History
Would Some Investors Have Been Better Off Not Chasing Alts?
If you close your eyes and think back to the mid-2000s, you can still hear it: the institutional investment world’s collective swoon over the “Yale model.”
The Yale model, developed by the late Chief Investment Officer of the Yale Endowment, David Swensen, emphasized an asset allocation with heavy exposure to alternatives such as private equity, hedge funds, and real assets rather than a traditional 60/40 public equity and bond portfolio. Swensen argued that less liquid and more inefficient private markets could reward patient investors with superior returns.
During his 36-year tenure, Swensen grew the Yale Endowment from $1.3 billion to over $40 billion, making it one of the most successful endowments in the world.1
And so, an idea spread: “Smart investors use alternatives.”
Regardless of staffing resources, liquidity demands, and portfolio scales, the gravitational pull of “alts” was irresistible. Pensions and foundations, small and large, wanted a taste of the legendary returns from private equity and hedge funds.
Now it’s 2026, and we have the benefit of hindsight, which allows us to assess how and why so many institutions migrated into the alternatives universe and how they’ve likely fared.
The punchline: Most institutions, especially smaller ones, would have been far better off doing absolutely nothing and simply sticking with a “boring” mix of public stocks and bonds.
Let’s explore the actual history as well as the alternative history—a world in which institutions didn’t chase alternatives.
The Yale model, developed by the late Chief Investment Officer of the Yale Endowment, David Swensen, emphasized an asset allocation with heavy exposure to alternatives such as private equity, hedge funds, and real assets rather than a traditional 60/40 public equity and bond portfolio. Swensen argued that less liquid and more inefficient private markets could reward patient investors with superior returns.
During his 36-year tenure, Swensen grew the Yale Endowment from $1.3 billion to over $40 billion, making it one of the most successful endowments in the world.1
And so, an idea spread: “Smart investors use alternatives.”
Regardless of staffing resources, liquidity demands, and portfolio scales, the gravitational pull of “alts” was irresistible. Pensions and foundations, small and large, wanted a taste of the legendary returns from private equity and hedge funds.
Now it’s 2026, and we have the benefit of hindsight, which allows us to assess how and why so many institutions migrated into the alternatives universe and how they’ve likely fared.
The punchline: Most institutions, especially smaller ones, would have been far better off doing absolutely nothing and simply sticking with a “boring” mix of public stocks and bonds.
Let’s explore the actual history as well as the alternative history—a world in which institutions didn’t chase alternatives.
The Great Drift Into “Alts”
In 2000, Swensen published Pioneering Portfolio Management, outlining his philosophy behind alternatives in his Yale model.
Since then, U.S. public pensions have dramatically reallocated—not by increasing risk per se, but by reshuffling the contents of their risk-seeking bucket. In 2001, alternatives accounted for only about 14% of risky assets. By 2021, they were nearly 40% (see Figure 1).2 Endowments, too, have increased their alternative allocation as a share of risky assets from 14% in 2001 (see Figure 1 again). By 2021, large endowments had allocated over half of their assets to alternatives. Smaller endowments, too, had allocated nearly 20% to hedge funds, real assets, and private equity.
Since then, U.S. public pensions have dramatically reallocated—not by increasing risk per se, but by reshuffling the contents of their risk-seeking bucket. In 2001, alternatives accounted for only about 14% of risky assets. By 2021, they were nearly 40% (see Figure 1).2 Endowments, too, have increased their alternative allocation as a share of risky assets from 14% in 2001 (see Figure 1 again). By 2021, large endowments had allocated over half of their assets to alternatives. Smaller endowments, too, had allocated nearly 20% to hedge funds, real assets, and private equity.
To fund the shift, national data indicate that U.S. public pensions mainly reduced public equity allocations—from 59% to 47%—while tripling allocations to “alternatives” from 11% to 30% over two decades.3
Why?
Not because of funding stress. Not because of forced reaching for yield. Not because of risk constraints.
Instead, textbook models of asset allocation tilted portfolios toward alternatives based on capital-market assumptions. In a typical mean-variance framework, an asset class is considered favorable (or has a higher alpha) if it is expected to earn more while being less correlated with public equities. In other words, an asset class is rewarded if it has higher expected returns, and penalized if it moves closely in line with assets already in the portfolio.
The keyword here is “expected”: a few simple assumptions can make alternatives look attractive. For example, one can easily assign higher expected returns to hedge funds or private equity.4 It’s also easy to assume that real estate and commodities would have lower correlations with public equities—and voilà, the model outputs a higher alpha.
It turns out that perceived alpha on alternatives has increased by 58 basis points over the last two decades, driven almost entirely by higher expected-return assumptions, which have led to higher allocations to alternatives among pension funds.5
Why?
Not because of funding stress. Not because of forced reaching for yield. Not because of risk constraints.
Instead, textbook models of asset allocation tilted portfolios toward alternatives based on capital-market assumptions. In a typical mean-variance framework, an asset class is considered favorable (or has a higher alpha) if it is expected to earn more while being less correlated with public equities. In other words, an asset class is rewarded if it has higher expected returns, and penalized if it moves closely in line with assets already in the portfolio.
The keyword here is “expected”: a few simple assumptions can make alternatives look attractive. For example, one can easily assign higher expected returns to hedge funds or private equity.4 It’s also easy to assume that real estate and commodities would have lower correlations with public equities—and voilà, the model outputs a higher alpha.
It turns out that perceived alpha on alternatives has increased by 58 basis points over the last two decades, driven almost entirely by higher expected-return assumptions, which have led to higher allocations to alternatives among pension funds.5
Where The Textbook Failed
The theoretical framework that favors alternatives applies primarily to large institutions with sufficient funds and investment resources for a few key reasons.
First, access is not equal. Large institutional investors get the phone calls from top-tier private equity funds first. Smaller institutions often receive allocations to a fund of funds, middle-market managers, or smaller, later-cycle funds. Sure, private equity funds can deliver superior returns to public equities, but the distribution is wide. In all but two of the past 24 years, at least one pension fund’s private equity allocation underperformed the broad market (see Figure 2).
First, access is not equal. Large institutional investors get the phone calls from top-tier private equity funds first. Smaller institutions often receive allocations to a fund of funds, middle-market managers, or smaller, later-cycle funds. Sure, private equity funds can deliver superior returns to public equities, but the distribution is wide. In all but two of the past 24 years, at least one pension fund’s private equity allocation underperformed the broad market (see Figure 2).
Second: fees, fees, fees.Alternatives could include up to 2% management fees, 20% performance fee on profits, and additional administrative, legal, and due diligence costs.6 For smaller asset owners, effective fees can easily reach 3–4% per year, all in.
Third, private assets require deep due diligence, ongoing monitoring, manager replacement decisions, cash-flow management, fair-value oversight, and board education. Small institutions rarely have the internal bandwidth. If you can’t evaluate managers rigorously, you’re buying an expensive black box. And the black box delivers only one thing reliably: fees.
Third, private assets require deep due diligence, ongoing monitoring, manager replacement decisions, cash-flow management, fair-value oversight, and board education. Small institutions rarely have the internal bandwidth. If you can’t evaluate managers rigorously, you’re buying an expensive black box. And the black box delivers only one thing reliably: fees.
Diversification Theater
Worse, for small funds, diversification from alternatives is a mirage. Large institutions build private equity or venture capital portfolios across many types of managers and strategies, whereas small institutions often don’t have the depth or capacity to do so.
Data also show that the diversification benefits of alternatives actually declined over time.7 In fact, the average returns of private equities and real estate funds move very closely in line with returns in the public equity market, while public U.S. bonds have maintained a negative correlation with public equities in most of the period since 1990 (see Figure 3).8
Data also show that the diversification benefits of alternatives actually declined over time.7 In fact, the average returns of private equities and real estate funds move very closely in line with returns in the public equity market, while public U.S. bonds have maintained a negative correlation with public equities in most of the period since 1990 (see Figure 3).8
In other words, did we replace a robust, proven diversifier (public bonds and equities) with an expensive, opaque alternative that doesn’t work that well?
There’s a gold lining, though: For small institutions without access to high-quality macro hedge funds, gold is one of the few alternatives on the list that’s liquid and has a lower cost, while improving portfolio resilience. Gold has S&P 500 Index-like volatility but near-zero long-term correlation with the S&P, posting positive returns in eight of the last 12 major equity drawdowns of more than 15% (see Figure 4).9
There’s a gold lining, though: For small institutions without access to high-quality macro hedge funds, gold is one of the few alternatives on the list that’s liquid and has a lower cost, while improving portfolio resilience. Gold has S&P 500 Index-like volatility but near-zero long-term correlation with the S&P, posting positive returns in eight of the last 12 major equity drawdowns of more than 15% (see Figure 4).9
Re-running The Movie
Now imagine a different world—the alternative history—where institutions didn’t look longingly at the Yale model and instead said: “Fascinating, but not for us. We have neither the staff, the scale, nor the governance for this. Let’s stick with what we can actually execute brilliantly: public markets.”
Imagine they had held 60% of U.S. public equities and 40% of U.S. bonds.
Costs would fall. Transparency goes up. Investment boards can understand what they own. Liquidity is always there. Cash flows are manageable with no lockups or capital calls. Stress tests are straightforward.
How would these institutions have done?
Pretty well, actually, albeit with more volatility. Some periods produced negative returns, such as most quarters in 2008 and 2021. However, over the long term, a U.S. stock-and-bond portfolio would have outperformed the median pension fund return by 50%, even without any rebalancing (see Figure 5).10 For funds that prefer more active management, overweighting bonds in market downturns would have further improved results.
Imagine they had held 60% of U.S. public equities and 40% of U.S. bonds.
Costs would fall. Transparency goes up. Investment boards can understand what they own. Liquidity is always there. Cash flows are manageable with no lockups or capital calls. Stress tests are straightforward.
How would these institutions have done?
Pretty well, actually, albeit with more volatility. Some periods produced negative returns, such as most quarters in 2008 and 2021. However, over the long term, a U.S. stock-and-bond portfolio would have outperformed the median pension fund return by 50%, even without any rebalancing (see Figure 5).10 For funds that prefer more active management, overweighting bonds in market downturns would have further improved results.
Still Waters Run Deep
Sure, private markets are famously smooth, but perhaps artificially so. Valuations are not reported daily, so they don’t move daily, which lowers perceived volatility (see Figure 6). Certain alternative assets, such as real estate, rely on appraisals for valuation that often lag actual asset performance due to reporting gaps.
But this psychological comfort comes at a price. When real liquidity is needed, the bids disappear. Imagine pulling out of a hedge fund or selling real assets during a market crisis; chances are, you are out of luck. Worse, the lack of a historical track record and financial regulation for alternatives may further amplify downside risks.
On the other hand, public markets are brutally honest. They mark prices down swiftly but also mark them back up just as quickly. You will find your counterparties willing to take your offer when you need it, even in market panics.
For small institutions, behavioral governance is simpler when focused on public markets: every holding is priced daily; volatility is visible and not suppressed; there are no capital calls; liquidity is available when needed; and the strategy is easy to explain to committees and auditors.
The best alternative for small institutions is no alternatives at all–just transparency, discipline, and keeping fees and costs in check.
On the other hand, public markets are brutally honest. They mark prices down swiftly but also mark them back up just as quickly. You will find your counterparties willing to take your offer when you need it, even in market panics.
For small institutions, behavioral governance is simpler when focused on public markets: every holding is priced daily; volatility is visible and not suppressed; there are no capital calls; liquidity is available when needed; and the strategy is easy to explain to committees and auditors.
The best alternative for small institutions is no alternatives at all–just transparency, discipline, and keeping fees and costs in check.
With The Benefit Of Hindsight
The real secret of the Yale model is not alternatives. It is scale, governance, and unique access. As Swensen mentioned in his book, alternatives are not for everyone—only “[a] few institutions exhibit the ability to commit the resources to produce risk-adjusted excess returns.”11
A smaller institution simply cannot replicate the elite access that large funds have, nor can it afford to ignore its liquidity needs.
If small institutions could redo the 2000–2025 investment era, the winning move—the highest volatility-adjusted return, the lowest governance burden, and the cleanest execution—would have been a U.S.-centric public equity portfolio, with a high-quality bond anchor, and maybe a low-cost diversifier (e.g., gold).
But it’s not too late.
The year 2026 may witness the moment when many institutions return to the most underrated allocation in history: a clean, transparent, low fee mix of stocks and bonds (see Did You Know? The Case For A 60/40).
In the end, the real alternative wasn’t private equity. It wasn’t hedge funds. It wasn’t venture, real estate, or infrastructure.
The real alternative was simplicity.
A smaller institution simply cannot replicate the elite access that large funds have, nor can it afford to ignore its liquidity needs.
If small institutions could redo the 2000–2025 investment era, the winning move—the highest volatility-adjusted return, the lowest governance burden, and the cleanest execution—would have been a U.S.-centric public equity portfolio, with a high-quality bond anchor, and maybe a low-cost diversifier (e.g., gold).
But it’s not too late.
The year 2026 may witness the moment when many institutions return to the most underrated allocation in history: a clean, transparent, low fee mix of stocks and bonds (see Did You Know? The Case For A 60/40).
In the end, the real alternative wasn’t private equity. It wasn’t hedge funds. It wasn’t venture, real estate, or infrastructure.
The real alternative was simplicity.
Did You Know?
The Case For A 60/40
A daily-priced public stock-and-bond portfolio can feel a little wild at times, especially as we head into 2026 after a roller-coaster 2025. For example, many investors find today’s elevated stock market valuations unsettling. However, it’s still possible to have good returns even at high valuations. In fact, approximately 55% of months since 1995 with valuations similar to today's have yielded positive returns. Ultimately, as long as the U.S. economy remains in expansion, U.S. stocks are more likely to deliver positive returns! For investors more concerned about a recession, bonds can come to the rescue. Today's elevated bond yields should provide some comfort—longer-duration Treasuries could offer double-digit returns in a recession as rates fall aggressively. Sure, monthly and quarterly returns may not always look great, but if you close your eyes and come back to your clean, public stock-and-bond portfolio 20 years later, you are far more likely to outperform alt-heavy peers.
Endnotes
- O’Leary, K. (2024, February 6). The evolution of the Yale model for institutional investing. Chronograph. https://www.chronograph.pe/the-evolution-of-the-yale-model-for-institutional-investing/
- Begenau, J., Liang, P., & Siriwardane, E. (2025). The rise of alternatives (SSRN Scholarly Paper No. 4940886). Social Science Research Network. https://doi.org/10.2139/ssrn.4940886
- Ibid.
- In the private equity and hedge fund universe, survivorship bias artificially inflates returns since only funds with strong performance are included in historical data, and closed funds are typically removed.
- Ibid.
- Feuer, J. A., Spangler, T. P., Koerner, J. P., De Leon, R. S., Kaal, W. A., Carmen, E. C., & Gray, E. P. (2017). Does “Two and Twenty” have a future? Private Fund Report, Lowell Milken Institute for Business Law and Policy, UCLA School of Law.https://lowellmilkeninstitute.law.ucla.edu/wp-content/uploads/2017/05/Private-Fund-Conference-2017_FINAL.pdf
- Begenau, J., Liang, P., & Siriwardane, E. (2025).
- We use Real Estate Investment Trusts (REITs)—publicly traded companies that own, operate, and manage income-producing commercial real estate—as a proxy for real estate investment returns. REIT performance captures changes in underlying property values as well as rental income, providing a market-based measure of commercial real estate returns.
- Erb, C. B., & Harvey, C. R. (2025, December 10). Understanding gold. Social Science Research Network. https://doi.org/10.2139/ssrn.5525138
- For the U.S. 60/40 portfolio, we assume 60% of assets are invested in the S&P 500 Index and 40% in the Bloomberg U.S. Aggregate Bond Index. We deduct a 1% management fee from each portfolio, which is the average management fee charged to a well-diversified endowment, according to a Commonfund study that appeared in the 2016 NACUBO-Commonfund Study of Endowments.
- Swensen, D. F. (2000). Pioneering portfolio management: An unconventional approach to institutional investment. Free Press.
This material reflects the firm’s current opinion and is subject to change without notice. Sources for the material contained herein are deemed reliable but cannot be guaranteed. This material is for illustrative purposes only and does not constitute investment advice or an offer to sell or buy any security. Past performance is no guarantee of future results. Point of View articles may not be reprinted without permission. We welcome your comments and feedback at editor@payden.com.
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