Market-Beating Returns in an Unleveraged Portfolio
Harry Markowitz, who popularized modern portfolio theory, said that “diversification is the only free lunch in investing.”
For most of the post-2008 period, the bull run in large-cap US equities meant that those who diversified well often found that lunch to be quite costly.
If someone went from a 100% stocks portfolio to the 60/40 stocks/bonds portfolio, the drawdowns in the latter would be shallower and the volatility would be lower. But also at the cost of long-run return.
Markowitz’ statement implicitly assumed that market participants can and will use leverage.
Since diversification generally leads to a better return-to-risk ratio, levering to your target volatility will lead to better returns for the same amount of risk relative to just being in stocks (or any one asset class).
The problem is that not everyone can leverage their portfolios. And even if they want to, leverage may not be accessible or cost-effective.
To get around this, to get their portfolio to achieve their return goals – while staying within acceptable risk parameters – there are certain tilts they can make or strategies they can pursue in their portfolios.
We look at these below.
Key Takeaways – Market-Beating Returns in an Unleveraged Portfolio
- Diversification works, but in the long bull market it often looked costly versus just owning US or developed market stocks.
- Markowitz assumed investors could use leverage, but many can’t or don’t want to. That’s why portfolios often default to stock-heavy allocations.
- Without leverage, you can still tilt smarter:
- Capital-efficient exposures like small caps, EM, futures, or long bonds free up capital.
- Risk parity balances equities, bonds, and commodities for smoother outcomes.
- Portable alpha adds diversifiers on top of cheap beta.
- Higher-vol alternatives make alts matter.
- Credit/private debt add income streams.
- Factor tilts like value or low-vol improve efficiency.
- Multi-strategy funds bundle diversifiers in one place.
Tilt 1: Move Toward More Capital-Efficient Market Exposures
What It Means
Not all stock or bond exposures are created equal. Some can provide better return (while still being within their personal risk tolerance).
For example:
- small caps
- emerging market equities, or
- private equity funds (for those who can access them through ETFs or listed vehicles)…
…generally pack more equity beta per dollar invested.
Similarly, longer-duration bonds can provide more yield while amplifying interest rate exposure.
Also, some traders use longer-duration bonds, but then hedge out the interest rate risk by shorting Treasury futures.
Why It Works
Higher-beta or longer-duration assets allow you to hold less of them while freeing up capital to diversify into other areas – or simply hold cash.
For example, the NASDAQ traditionally has provided close to 2% in extra annual return than the S&P 500 at a standard deviation of volatility of around 23% (vs. 15% for the S&P).
So, if you believe that the forward return is similar, a portfolio of 80% NASDAQ could give around similar return to the S&P 500 (though still at higher volatility).
But that 20% can be reserved for other assets or strategies, like bonds or cash.
Watch Outs
High-beta assets aren’t always a free lunch.
Research shows investors often overpay for them, which drags down long-run returns.
Sometimes you simply add more risk without being compensated for it – e.g., concentrated approaches where you have too much idiosyncratic risk when you don’t actually want to bet on a specific company, industry, or theme.
Leveraged ETFs, in particular, can suffer from compounding drag in choppy markets. They’re more for day traders in the truest sense – holding within the day only to avoid the drag.
Small caps, EM equities, or certain long-duration bond ETFs may offer better efficiency without the structural decay.
Tilt 2: Consider Risk Parity Approaches
What It Means
Risk parity strategies balance portfolio risk across asset classes, often levering up bonds and other diversifiers so equities don’t dominate.
While institutions pioneered this, individual traders/investors can either do this themselves if they research how to do it.
And now, they can access risk parity ETFs or mutual funds.
ALLW is one such example. (Always look at fees and do research before committing.)
Related
Why It Works
Instead of being stuck with 60/40 (which has long been considered a common model portfolio/stock-bond benchmark), where equities drive most of the outcomes (generally 85-90% as they have structurally longer duration), risk parity aims for a smoother ride by scaling up the safer assets.
That way, bonds and alternatives matter as much as equities in driving returns.
For example, if a portfolio is 60% equities and 40% bonds, it would add bond futures and, e.g., gold futures to balance out the equities so it doesn’t dominate the allocation.
Watch Outs
Risk parity generally lagged during the post-2008 equity bull market because equities ran away given the existing slack in the market, plus low rates and aggressive money printing.
Its moment tends to come when stocks struggle.
Those in risk parity need patience, and they need to accept that their friends in plain 100% equity portfolios may outperform them for years at a stretch.
Depending on the volatility/risk level of the portfolio, equities may outperform risk parity, in general.
Fundamentally, the general goal of the strategy is to outperform in risk-adjusted terms, which may not benefit those looking for absolute returns.
Tilt 3: Use “Portable Alpha” or Alpha-Beta Hybrids
What It Means
Portable alpha combines a cheap index exposure (like an S&P 500 ETF) with a diversifying active strategy layered on top.
This often comes in the form of hedge fund replication ETFs or long/short factor funds.
The idea is you don’t have to give up beta (passive exposure) to add alpha (market-beating returns).
Why It Works
You get the market return plus potential diversifiers without having to sell your equities to fund them.
As a very basic example, let’s say someone has a $100,000 account.
So they do:
- $100,000 VT (a global stock market ETF)
- $40,000 in gold futures
The gold futures gives them an overlay on the portfolio, so they get the stock returns plus the extra return from a diversifier (be aware that the leverage cost is embedded in futures contracts).
For example, a portable alpha ETF might hold index futures plus a multi-strategy liquid alternative sleeve.
Watch Outs
Fees can eat away at the benefit if you’re not careful.
And not all “liquid alts” deliver uncorrelated returns. Some still take too much equity risk (like most products).
Look for transparent strategies and reasonable performance fees.
Tilt 4: Allocate to Higher-Volatility Alternatives
What It Means
Many hedge fund-style ETFs or liquid alts target low volatility.
They’re so low that they may not move the needle in your portfolio.
Most of them are not accessible for individual traders/investors and more geared toward a certain type of client who needs risk-managed, non-correlated returns streams (e.g., pension funds, sovereign wealth funds).
Instead, you can look for higher-volatility versions of these strategies.
For example, HFGM (targets higher volatility and returns while also trying to differentiate from equity returns).
Why It Works
Choosing a higher-volatility alternative allows you to invest a smaller slice of your portfolio and still get meaningful diversification.
This frees up capital for equities or bonds without watering down the impact of the alternative.
Watch Outs
Line-item risk. A higher-volatility ETF may show double-digit drawdowns on its own, even if the total portfolio impact is muted if it’s not a large portion of it.
Tilt 5: Add Credit and Private Debt Exposures
What It Means
Beyond investment-grade bonds, investors can reach into high-yield credit, bank loans, or private credit funds (sometimes available in listed formats).
These often bundle in some embedded leverage, since the companies issuing them already run with higher debt loads.
Why It Works
Credit adds another source of return that isn’t purely equity or duration – though there are components of that.
Historically, high-yield and private debt have delivered equity-like returns with less volatility, thanks to income.
They can be especially useful for freeing up equity allocation while still keeping return expectations high.
Also be aware that these can be less liquid. It’s important to not mistake things as “safer” just because you don’t see the price move.
Watch Outs
As mentioned, liquidity is the big trade-off.
Many private credit or interval funds lock up capital, and even listed high-yield ETFs can trade with wide spreads during stress.
For example, the VPC ETF (a private credit strategy packaged into ETF format), has a median bid-ask spread of 0.34%.
By contrast, large equity ETFs are generally 0.01-0.02%.
Also, credit can correlate with equities during recessions, so it’s not a pure diversifier.
Also, be aware of fees.
HYIN – another private credit and alternative income ETF – has, on top of its 0.50% manager fee, another 3.82% in costs from the funds it invests in, leaving less of its headline 9-12% yield for you.
Tilt 6: Use Low-Risk or Factor-Based Equity Strategies
What It Means
Instead of just piling into high-beta equities, investors can tilt toward factor exposures like low volatility, quality, or value via ETFs.
The evidence suggests these factors have historically delivered market-like returns with less downside.
Why It Works
You get more efficient equity exposure – similar or better long-run returns than the cap-weighted index, but with smaller drawdowns.
Watch Outs
Factor performance is cyclical. Value can underperform for a decade (it has for most of the post-2008 period), and low-volatility stocks can be crowded.
You can end up paying a lot for high-quality cash flows.
Investors need patience and the willingness to rebalance when a factor is out of favor.
Tilt 7: Look for Multi-Strategy or “All-in-One” Funds
What It Means
Some ETFs and mutual funds package multiple diversifiers into one sleeve: equity beta, alternative risk premia, managed futures, credit, and more.
This is similar to a hedge fund-of-funds but available in liquid format.
Related
Why It Works
It combats the “line-item” problem.
Instead of having ten tiny allocations that individually don’t move the needle, a multi-strategy vehicle can deliver meaningful diversification in a single fund.
This also reduces behavioral risk – traders/investors are less likely to panic-sell when one diversifier is having a bad year.
Watch Outs
You’re outsourcing a lot of trust to the manager.
Fees can also be higher than buying individual sleeves yourself.
The key is finding a fund with true diversification, and not just repackaged equity beta.
Example Portfolios
So, let’s make this concrete with example portfolios that show how these tilts could actually look in practice.
We’ll keep allocations simple, realistic for an individual investor (ETFs, liquid formats), and tied back to the framework we covered.
Portfolio 1: Traditional 60/40
- 60% US Equities (e.g., S&P 500 ETF: SPY)
- 40% US Bonds (e.g., Aggregate Bond ETF: AGG)
This is the old benchmark.
Lower volatility than 100% equities, but long-run returns often trail because equities dominate the compounding effect.
Portfolio 2: Capital-Efficient Market Tilt
- 40% US Equities (SPY)
- 20% NASDAQ (High Beta Equity) (QQQ)
- 20% US Bonds (AGG)
- 20% Emerging Markets Equity (EEM)
Here, we swap some S&P exposure for NASDAQ and EM, which carry higher beta.
That lets us free up capital for more bonds without giving up expected equity exposure.
Portfolio 3: DIY Risk Parity Light
- 35% US Equities (SPY)
- 25% Bonds (AGG or TLT for more duration)
- 20% Commodities/Gold (GLD or DBC)
- 20% Managed Futures / Risk Parity ETF (ALLW or RPAR)
This balances equity risk with bonds and commodities.
The goal isn’t to maximize equity upside but to stabilize outcomes across regimes/environments.
This way you’re not so skewed toward equities holding up.
Portfolio 4: Portable Alpha Hybrid
- 60% Global Equities (VT)
- 20% Bonds (AGG)
- 20% Portable Alpha ETF / Hedge Fund Replication (e.g., MFA, HFND, or a futures overlay strategy)
This overlays an active diversifier on top of equity beta without having to sell equities.
In practice, this might mean holding an S&P ETF and layering in a managed futures strategy that runs long/short across global markets.
Portfolio 5: Higher-Volatility Alternatives
- 50% US Equities (SPY)
- 20% Bonds (AGG)
- 20% High-Vol Liquid Alts ETF (HFGM, HFND)
- 10% Gold (GLD, IAU)
The higher-vol alts sleeve makes a real contribution to portfolio diversification, unlike many low-vol hedge fund replication products that don’t move the needle.
Portfolio 6: Credit and Private Debt Tilt
- 40% US Equities (SPY)
- 20% Bonds (AGG)
- 10% High Yield Credit (HYG, HYD)
- 10% Private Debt ETF (HYIN, VPC)
- 20% Alternatives (Managed Futures or Multi-Strategy) (DBMF, KMLM, or HFMF)
This tilt uses private credit / high yield as an income engine, while keeping a diversifier sleeve.
Portfolio 7: Factor & Multi-Strategy Blend
- 40% US Equities (Factor Tilt) (USMV or QUAL for low-vol/quality tilt)
- 20% Global Value Equities (VTV or EFV)
- 20% Nominal/Inflation-Linked Bonds (AGG, TLT, TIP)
- 20% Multi-Strategy ETF (RPAR, ALLW, or multi-asset liquid alt funds)
This combines factor tilts with a one-stop diversifier, lowering drawdown risk while still looking for market-like returns.
Each of these shows a different way around the leverage gap: higher-beta equities, balanced exposures, overlays, alts, credit, or factor tilts.
They’re not prescriptions but blueprints/ideas for how an individual investor could apply the ideas in ETF form or how a trader could structure their portfolio while trading more tactical ideas.
Conclusion
The problem isn’t that diversification doesn’t work. It’s that, without some bit of leverage, most investors can’t fully take advantage of it.
If you can lean on more capital-efficient exposures, risk-balanced approaches, portable alpha, and higher-volatility diversifiers, it helps to get closer to the “free lunch” that Markowitz described – without needing access to hedge funds, private equity, or more specialized strategies.