At BBH, we are always searching for differentiated investment strategies that can help enhance long-term portfolio returns while reducing risk. Over the past few years, we have been particularly focused on adding independent return strategies that can provide equity-like returns but with lower volatility. While we believe this provides unique diversification and return benefits in all environments, independent return strategies can play a particularly valuable role during periods of higher equity market valuations. Here, we explain how incorporating independent return strategies can play a key role in enhancing a portfolio’s return potential, diversifying return sources, and positioning it for the future.

Market context and portfolio positioning

Despite continuous headlines about volatility and uncertainty, market performance has been strong over the past five years – note the S&P 500’s 16.6% annualized return, which represents a top-quartile return for the index. As shown in the nearby chart, the S&P 500’s first-quartile five-year annualized return between 1988 and second quarter 2025 was 15.8%. Of the 390 rolling observations, the index generated a return greater than 16.6% only 20% of the time.

Though unpredictability is likely, historical precedent would suggest that the S&P 500’s success of the last five years is unlikely to continue indefinitely. We must be prepared for this scenario, as using our capital market expectations and based on a variety of analyses, we would be unsurprised to see large-cap equities return mid-to-high single digits annualized over the next 10 to 20 years. We expect inflation to reduce the real return by at least 2% to 3% annualized, implying that holding a simple portfolio of stocks and bonds may not be sufficient for many investors to meet their goals and objectives.

To mitigate this possibility, we structure portfolios in the following ways:

• We suggest a public equity portfolio composed of exceptional public equity managers with the ability to generate long-term outperformance across market environments and economic cycles.
• We suggest that those suitable who can access private investments add them to their portfolios, as they can provide the potential for a return premium above public market equivalents.
• We encourage the addition of independent return strategies. These are strategies that can enhance the overall portfolio return profile by generating uncorrelated equity-like returns without being driven by broad equity or credit market conditions while lowering expected portfolio volatility.

Why market dependence is a hidden risk in your portfolio

Even traditional portfolios that appear diversified are often more correlated to broad equity market returns than they appear. Despite allocations across asset classes, most investments within a portfolio will rise and fall together in periods of market stress, as correlations tend to increase alongside volatility. As shown in the following chart, we have also seen assets like traditional public equities and fixed income become more correlated over time, for reasons including increased globalization, central bank action, and the rise of high-frequency trading.

True diversification means adding return streams not tied to market direction. This is why we have been deliberate in looking for exceptional investment opportunities that can provide attractive returns that are less correlated to market movements. Independent return strategies are such an opportunity.

What are independent return strategies?

We define independent return strategies as compelling investment opportunities that aim to generate equity-like returns with low beta¹ to public equity markets. With such strategies, we expect investment manager skill (alpha),² as opposed to market exposure (beta), to produce the vast majority of performance. Therefore, the return stream does not correlate with systemic risk factors, making it a valuable portfolio diversifier. Independent return strategies are the quiet workhorses of sophisticated portfolios that have the potential to smooth compounding over the long term.

In our view, independent return is not an asset class, but instead falls under one of our second-order capital allocation frameworks: role in the portfolio. Within this, we categorize investments into four different categories, including:

• Long-term inflation protection and growth (public and private equity)
• Deflation protection, income, stability, and liquidity (fixed income)
• Unexpected inflation protection (real assets)
• Independent return (variety of strategies and asset classes)

Independent return strategies are not a single type of strategy or product. They can come in a variety of fund structures and liquidity profiles. Such strategies can be accessed via evergreen (i.e., open-ended, non-drawdown) structures or private equity-style drawdown vehicles, for instance.

While these strategies may vary in terms of investment focus and strategy, the successful ones are often skilled at taking advantage of inefficiencies and mispricings to drive returns independently from public equity markets.

Examples of independent return strategies include:

• Opportunistic
• Event-driven (including distressed debt)
• Insurance-related
• Multi-strategy
• Structured credit/equity
• Royalty-related
• “Tweener” strategies that do not fit easily into definable categories

This last category is worth elaborating. Organizational structures at investment firms often reflect asset class categories, which can result in exceptional investment managers being overlooked because they do not fit neatly into a defined category. For example, investment managers who invest across the capital structure and hold private and public securities as well as equity and credit securities can prove challenging to implement within traditionally structured investment organizations.

Like independent return strategies, our Investment Research Group (IRG) is structured in a generalist model so that all investment ideas compete for capital, and we can take advantage of these structural inefficiencies to find overlooked, yet exceptional, investment partners.

What do we look for in independent return strategies?

We take a differentiated approach to building portfolios. The bar for portfolio entry is extraordinarily high, and all investment opportunities compete for capital against other opportunities. As a result, our portfolio is a collection of our best ideas. We invest only in the “best of the best” independent return strategies that we believe will add value to our portfolios and align well with our “10 Ps” framework.

Exceptional investment managers who can generate strong returns independent of public equity and fixed income markets are rare, so manager selection is critical to success. In looking for independent return strategies, we focus on finding strategies that will likely benefit from significant and persistent market inefficiencies while providing strong after-fee, after-tax returns.

Investment partners must have explainable processes for exploiting inefficiencies, know what they own and why they own it, and have an ability to assess and appropriately manage risk, among other considerations. Notably, we do not start by looking for portfolio diversifiers. Such an approach can result in the selection of managers that may reduce volatility but also reduce the long-term portfolio return potential. Instead, we focus on strategies that can produce similar or better long-term returns as public equities, but with return streams that look different from public equities.

Our independent return strategies must also generate attractive after-tax results that are comparable with public equity markets. Some categories of these strategies, such as long/short equity or high-turnover strategies, are capable of generating high returns but are often less attractive on an after-tax basis. We tend to avoid these for our taxable clients, though we are always looking for the exceptions.

How to thoughtfully incorporate independent return strategies

Given their meaningful benefits, we believe that independent return strategies should compose approximately 10% to 25% of a portfolio, depending on a client’s goals, risk profile, liquidity needs, and objectives. The higher allocation is more appropriate for those who can access independent return strategies in illiquid drawdown structures as well as their more liquid counterparts. For those individuals, it typically takes commitments over several years to reach the desired long-term targets.

One of the biggest challenges with independent return strategies is that they are difficult to benchmark over short time periods. By definition, their returns should not be highly correlated with traditional benchmarks. This is where our long-term orientation, and our clients’ trust, creates value. Over the long term – which we think of as a full market cycle, or at least five to 10 years – we would expect these strategies to generate returns comparable to, and hopefully in excess of, public equity markets while smoothing the return stream of an overall portfolio.

Like any other investment strategy, independent return strategies must be closely monitored to ensure they are playing their desired role in the portfolio. We watch performance attribution, exposures, stress cases, and factors, among other considerations. Due to their low equity market correlation, we also closely monitor opportunities to rebalance the overall portfolio, which can facilitate higher long-term portfolio returns.

Conclusion

For years, many investors have viewed equities as the engine driving long-term returns and fixed income as the steering system and brakes that provided control and reduced risk. Our rigorous approach to selecting exceptional independent return strategies allows them the potential to be both the shock absorbers of a portfolio and additional horsepower to drive long-term equity-like returns. This is why we believe that the addition of independent return strategies is not a trend. Instead, it represents the foundation for preserving and growing wealth in an unpredictable world.