The first quarter of 2025 marks a period of transition and opportunity for the global economy and financial markets. Below, we highlight some key trends and considerations shaping the investment landscape for the year ahead.
Economic Resilience and Growth Potential
The U.S. economy has demonstrated continued resilience, even in the face of significant monetary tightening over the past two years. We believe fiscal stimulus and potential adjustments in interest rates are expected to provide additional support to economic activity in 2025 and beyond. This environment may create a constructive backdrop for various asset classes, including public equity, private equity, credit, and real estate.
Inflation and Interest Rates: A Shifting Dynamic
We believe an already strong economic backdrop, coupled with persistent fiscal deficits, could contribute to persistently higher inflation levels compared to the Federal Reserve’s 2% target. Investors may want to consider asset classes with potential inflation-hedging characteristics, including equities, floating-rate credit, and real assets, as part of a diversified strategy.
"We are entering a period where inflationary pressures could remain elevated, and this potentially requires a strategic shift in portfolio construction," notes Jeff Sawin, Managing Director at IEQ Capital.
Adapting to Elevated Valuations and Market Correlations
Higher valuations and increased correlations between stocks and bonds may present challenges for both the return and diversification potential of traditional asset allocations. We believe incorporating alternative investments, such as private equity, private credit, and real estate, could help enhance portfolio outcomes over the long term by providing additional sources of return and diversification.
Exploring Opportunities in Alternatives
Private Credit: Higher interest rates could support favorable returns for private credit, performance and relative value compared to public markets may support private equity’s role in long-term portfolio strategies.
Private Equity: Solid operational performance and relative value compared to public markets may support private equity’s role in long-term portfolio strategies.1
“Stock and bond correlation dynamics are being tested in ways we have not seen in decades," explains Daniel Lee, Managing Director at IEQ Capital. "This is where alternatives can potentially add meaningful value with opportunities designed to be uncorrelated."
Venture Capital: Stabilizing valuations and a reopening of capital markets could position venture capital for renewed growth, including transformative technologies such as Artificial Intelligence.
Secondaries: The secondaries market offers potential value for investors seeking discounted access to private equity and other alternative assets.
Equity Markets: Cautious Optimism
While equity markets have drawn comparisons to the late 1990s, the current environment is underpinned by solid macroeconomic conditions and corporate earnings growth that keep us optimistic on the trajectory of the market. Investors should brace for volatility and corrections along the way, but we believe it is a generally favorable backdrop for a continuation of this multi-year bull market.
"The economy's ability to absorb such significant rate hikes and still maintain growth is a testament to its underlying strength," says Aaron Price, Partner at IEQ Capital. "However, we need to stay mindful of how fiscal policy and monetary easing interplay in the coming quarters."
Fixed Income: Opportunities Amid Normalization
With yields normalizing, high-quality bonds may present potential opportunities relative to cash. However, we believe active management and careful consideration of duration and credit risks remain essential to navigating this segment of the portfolio over the coming years.
Real Estate: Gradual Recovery
We believe real estate markets are likely to continue on a slow recovery in 2025, with stabilizing valuations and improving capital markets which may support prospective returns. A reopening of capital markets likely accelerates deployment and realization activity relative to the last two years.
Preparing for the Future
As we enter 2025, we believe the economic and market landscape argue for a more flexible approach to asset allocation. Investors may consider an approach that incorporates both traditional and alternative asset classes, focusing on diversification and inflation resilience as core portfolio themes.
1. The S&P 500 Index, a widely recognized measure of U.S. public equity market performance, is used for comparison purposes; it is not directly comparable to private equity and carries different risks.
Past performance is not indicative of future results. An investment represents a high level of risk. An Investor should be prepared to bear the risk of a total loss on his/her investment. An investment on behalf of other clients in a specific asset class does not mean that it is a suitable or advisable investment for you. IEQ typically charges different fees for different asset classes and thus may have an incentive to recommend certain asset classes over others. Forward looking statements/return projections are not statements of facts but merely an expression of opinion and belief. You are cautioned that a number of important factors could cause actual results or outcomes to differ materially from those expressed in, or implied by, the forward-looking statements. Nothing herein constitutes investment, legal, tax, or other advice.
Equities
- Macro Risk. Macro factors including interest rates, inflation, or economic growth may lead to materially different return outcomes for the sector, particularly if there is a material impact to earnings outlooks
- Interest Rate Risk. Higher interest rates may adversely impact equity valuations.
- Mark to Market Risk. Equities are relatively volatile securities and may be especially volatile in a poor macro backdrop.
Private Equity
- J-curve Risk. Private Equity and Venture Capital funds typically experience a more severe j-curve than other alternative investments strategies driven by the longer timeline to appreciation and lack of distributable cash flow early on.
- Macro Risk. Multiple contraction, erosion of consumer demand, and increased costs of leverage could negatively impact a fund.
- Execution risk. Private Equity and Venture Capital investments will typically leverage operational expertise to add value to underlying portfolio companies, there lies risk that the operational team cannot perform to add value within a fund.
Private Credit Overview: Risk Summary
- Credit risk. Private companies are usually unrated or below investment grade, and may be more susceptible to default.
- Competitive Risk. Direct Lending is a crowded space with lenders competing on price and weaker covenants.
- Liquidity Risk. There is no guarantee that a fund’s liquidity mechanisms will be reliable, and the managers are under no obligation to provide liquidity. In a downturn where investor outflows increase materially, investors are likely to experience periods of gating and potentially will be unable to redeem fully.
- Mark to Market Risk. Certain portfolios may own liquid loans or mark to liquid markets, resulting in fund volatility.
- Tax Risk. Lending is generally tax-inefficient and post-tax returns may be materially lower than pre-tax returns.
Real Estate – Value Add
- Tenant Credit Risk: There is risk that the tenants of the underlying properties could fail on their rent payments which would ultimately negatively impact cashflows, yield, and return.
- Interest Rate Risk: there is risk involved if rates were to increase, from both a financing and asset value perspective, and rents may not grow fast enough to offset inflation.
- Execution Risk. Value-add can involve significant execution risk specific to renovation, lease-up, and/or development to drive returns.
- Competitive Risk. There are many market participants in the value-add space, and heightened competition may limit deal flow or ability to source attractive deals.
- Liquidity Risk – exit strategies are typically contingent on capital markets and prevailing appetite for risk, which may ebb and flow with the cycle.