In the ever-evolving landscape of investment strategies, return stacking has emerged as a powerful approach for portfolio diversification without sacrificing exposure to traditional asset classes. As explained by Corey Hoffstein, owner of Newfound Research, this strategy—originally known as portable alpha when pioneered by PIMCO in the 1980s—offers investors a way to maintain their core investments while adding diversifying elements that can enhance returns and reduce overall portfolio risk.
The fundamental challenge that return stacking addresses is what Hoffstein calls “the funding problem of diversification.” Traditional portfolio construction typically requires investors to sell some existing assets (usually stocks or bonds) to make room for alternative investments or diversifiers. This creates a behavioral dilemma: when those diversifiers underperform relative to core assets (as many did during the 2010s bull market), investors face immense pressure to abandon their diversification strategy and chase returns. This behavioral gap has real consequences—Morningstar research shows that while managed futures strategies earned approximately 6% annualized returns over recent years, the average investor in these funds only captured about 3% due to poor timing of entries and exits.
Return stacking offers an elegant solution by using capital efficiency to maintain existing exposures while adding diversifying strategies on top. Rather than selling stocks or bonds to make room for alternatives, investors can use investment vehicles that provide leveraged exposure to core assets, thereby freeing up capital for diversifiers. For instance, instead of allocating 60% to stocks directly, an investor might put 30% in a fund offering 2x exposure to the S&P 500, effectively maintaining the same 60% stock exposure while freeing up 30% of the portfolio for alternative investments like managed futures, gold, or merger arbitrage strategies.
This approach is best understood through Hofstein’s housing analogy: rather than using all your cash to buy a house outright, you could put 20% down, take a mortgage for the rest, and invest the remaining capital in different assets. So long as those investments outperform your mortgage interest rate, you’ve enhanced your overall return while diversifying away from a single asset. The key difference in institutional investing is that financing costs are typically much lower than consumer mortgage rates, making the strategy more accessible and potentially more profitable.
The beauty of return stacking is that it can help solve both performance and behavioral challenges. During periods when alternatives underperform (as they inevitably will at times), investors still maintain their core exposures to stocks and bonds, making it easier psychologically to stick with a diversified approach. Then, when markets experience stress—as in 2008 or 2022 when stocks and bonds both declined simultaneously—those diversifiers can shine, providing returns when traditional assets struggle.
It’s important to note that leverage, when used thoughtfully for diversification rather than concentration, can actually reduce portfolio risk. While many investors rightfully associate leverage with financial disasters, the issue is typically not leverage itself but rather how it’s applied. Using leverage to concentrate into a single asset class (like buying multiple houses in the same neighborhood) amplifies risk, while using it to diversify across uncorrelated assets can create more stability. As Hoffstein points out, some of the most robust institutional portfolios in the world, like Bridgewater’s All-Weather Fund, use leverage extensively to create broad diversification across many different return streams.