Not all privates are created equal: Our alternative framework for 2025

Foreword

We founded Opto to fix a broken private markets system. In order to do that, we needed to build a business from the ground up that did not have the constraints or (faulty) legacy incentives this market is built on. Quite simply, we needed to reinvent it for the long term.

We do not offer static fund menus of asset gatherers, because we are not compensated by fund managers, which enables an undiluted focus on quality. We guide our partners towards what we determine to be elite opportunities, building off of relationships with truly exceptional members of the investment community and filtered through our robust diligence process.

This is a genuinely exciting position to be in - and creates deep alignment with our partners.

We see a lot of investments from our extensive network - thousands and thousands a year. We have approved for investment only 1.4% of funds that we moved forward into the screening phase, meaning 98.6% did not make the cut.¹ We flex the power of saying no. We take pride in that. Saying no to most means we have the conviction and muscle to say yes where it counts. We've assembled a strong network of allocators, investors, builders, founders, and financial pioneers to challenge the status quo and fix this market.

When we approve an investment, it's with purpose. When we pass, it's with conviction. 

We recognize that we do not have a monopoly on good ideas. We partner with our clients to maintain a dynamic view of the most attractive places to allocate and the highest potential managers to access these assets, themes, and ideas - and welcome vigorous debate. But we are principled, bold, and selective, and will not whitewash poor performance. We might make money faster if we did - or if we let fund managers pay us for that approval. That is not why we founded Opto.

Our entire mindset and company structure are focused on the long-term success of our partners. We raised an outsized amount of capital to allow us to take a holistic view of our client relationships, rather than focusing on the next dollar, and to implement a bold, novel business model where we succeed only if our partners and their clients are meeting their goals.

We are here to consign diluted, overpriced, and misaligned private investments to the past. If that sounds exciting to you, get in touch to help us build the future.

Jacob Miller

Co-founder, Chief Solutions Officer (LinkedIn)

Do private markets better: partner@optoinvest.com

An alternative framework

This bold reinvention of the industry means we must have bold, long-term views on the private investment landscape, on many levels. In which asset classes do we see a good entry point? Where is there too much dry powder and not enough opportunity? Are the investable themes strong enough that we can look through a potential economic headwind, or will it hamper our entry? Are there transformations taking place in the economy and in how progress is funded, and can we participate before everyone catches on? Do economic risks create gaps in public market strategies that private markets can fill? 

This is a lot to work through every year. We allocate manager-by-manager, vintage-by-vintage, deal-by-deal. Opportunities exist for short windows. There is no investable index.

However, we have a framework that helps simplify and standardize our approach. This also allows us to form stronger hypotheses, revisit these hypotheses over time, and hold ourselves accountable. By systemizing our understanding, we can compound it. By compounding on our understanding, we can improve our thinking faster than the market. And by clearly exposing our framework, we invite conversation from our network of allocators, managers, founders, and financiers, and accelerate progress. 

A simple observation

It starts with a simple observation. The best time to invest is when you find:

1. An emerging theme or trend in markets that looks likely to create real value in the next 5-10 years, regardless of economic environment - e.g., AI today, cloud computing in the 2010s, or multi-family real estate post-financial crisis.

2. A macroeconomic backdrop supportive of the asset class or classes poised to take advantage of this trend.

Macro and thematic alignment: 2010s cloud computing wave

This sort of aligned setup was present in the early 2010s. Big data was a relatively new term, and was everywhere. Data-intensive applications were growing and not just on computers that might have the on-machine hardware to run them, but also on smartphones with real computing and storage constraints. Concerns were rising about data security with an increasingly mobile workforce. There was an unprecedented amount of data being generated.

At the same time, we had exited the Global Financial Crisis (GFC) and growth was robust. However, inflation remained tepid and debt was high. The Federal Reserve stuck to its zero interest-rate policy and continued rounds of quantitative easing. This capital flowed out and decreased price sensitivity, as investors had to find places to put capital and get close to their required rates of return, which was no longer going to happen in much of fixed income. To support the economy, the federal government was generally accommodative to mergers and acquisitions, with transaction volume relatively high. After some slow years in and after the GFC, IPO markets were alive and kicking.

This made it an ideal time to be an early-stage venture capital (VC) manager. Much of the core infrastructure, developer toolkits, and other backend services to support a move to the cloud had yet to be created. At the same time, leaders and emerging leaders in the space (AWS, etc.) could leverage extremely low cost of capital to make acquisitions. This led to highly valuable, relatively quick exits through acquisition for early-stage backers of deep tech founders. These vintages yielded some of the strongest and fastest-delivered early-stage VC returns on record (see chart).

Private infrastructure also benefited, particularly digital infrastructure and the real estate it sits on. While cloud computing sounds better, warehouse computing is more accurate. The storage and computation has to happen somewhere! By building large data centers in areas that had natural benefits (cheap power, lower temperatures, etc.), cloud providers could scale services efficiently. This required not just buying the real estate, but investments in power generation, hydro-related projects (for large-scale cooling), and high-speed telecommunications to interact with the cloud - and all supported by low interest rates that drove elevated spreads.

When top-down (macro) and bottom-up (thematic) forces align like this, it makes spotting the most exciting private opportunities much easier. If only every year was so clear.

2025 is not 2010. The macroeconomic picture is far murkier, but there are key drivers which we can take educated views on. As for themes, we see several in 2025 that we will - with apologies for the suspense - share in part two of our outlook. 

How do private asset classes connect to the economy?

It is important to understand how private markets react to fundamental economic factors.

The first thing we need to point out is that private assets definitively do not all operate the same way and are not all equally sensitive to the macro economy. Nor do private asset classes necessarily react the same way to changes in conditions as their public counterparts. 

Real estate, for example, is very macro: sensitive to the cost of borrowing, to perceived risk (which makes capital harder to source), and to demand. Commercial real estate in particular is highly growth sensitive, as businesses only demand more space when things are going well. Even the best real estate managers will likely perform under expectations if interest rates spike and incomes weaken.

On the other hand, early-stage VC is relatively disconnected. Investments are made with long-term exit horizons - typically five to 15 years, and companies generally win by taking market share within a specific market (or creating a new market), rather than relying on the growth of that market to succeed. While there is some sensitivity to  the fundraising environment and acquisition activity, and VCs might have more mark-ups in a high-growth environment, the long-term potential of their investments is quite idiosyncratic.

Different assets have very different betas to economic conditions, as well as varying overall levels of sensitivity (see chart). In a forward-looking decade of increased economic uncertainty, private markets offer the opportunity to reduce overall portfolio sensitivity to aggregate conditions - while not necessarily having to accept lower returns to do so.

In some cases, biases towards/sensitivity to drivers are similar to their public counterparts. VC and private equity (PE) both have slight biases to growth (i.e., returns are higher in periods of rising growth than falling growth) (see chart). However, some are entirely different. Credit can outperform in rising inflation environments given floating-rate structures. Infrastructure can provide a safe haven in periods of sharply rising interest rates, as infrastructure’s relationship to commodities and base goods - drivers of inflation, and therefore rate rises - provide tailwinds as other assets lag.

These lower biases have material impacts on compounding of returns. Shown below, while PE performs better in rising growth, since 2007, its performance in periods of falling growth has still been positive, providing even more upside capture in upswings, as investors compound from a higher base (see chart).

Fundamental signals by asset class

Having established the extent to which the different asset classes are responsive to macro impulses, we need to actually figure out what those macro impulses will be over the coming year.

So, the big picture. We remain relatively bullish on growth. An easier regulatory requirement, the need to pursue capex in the face of tariffs, and a generally supportive consumer sector, mean to us that 2025 could easily outstrip economist consensus. The table below is a breakdown of where we see risks (to the upside or downside) to market expectations for 2025:

Above-expectation growth would have meaningful implications for other factors. In particular, it would place upward pressure on inflation, which is currently priced at only 2.42% via inflation-linked bonds. Higher or persistent inflation would have knock-on effects on discount rates and availability of credit, making the flat-to-slightly-down current expectations seem a shade optimistic. 

Lastly, while risk levels - as measured by the VIX and MOVE indices - are elevated, the compensation investors get for taking on risk is, by our measure, at secular lows. An expansion in what investors expect in return for taking on risk would mean a pricing reset, and would drag on most assets.

The fact that we are at secular lows for expected risk premiums, after a decade of quantitative easing (QE) and zero interest rate policy (ZIRP), is likely to be a defining factor for the next decade. As shown below, ten-year returns from the classic 60% equity, 40% bonds portfolio have historically correlated with our forward-looking measure of risk premia (see chart). (We have shifted the realized returns from the 60-40 backwards ten years to illustrate the correlation.)

Put another way, when expected risk premia have been low, so have returns for public market investors over the next ten years.

It is not a perfect relationship, as certainly other factors drive markets, but the correlation has held pretty well for more than 120 years. This means investors should probably pay attention to the downward trajectory of the risk premium metric. If the baseline return from just taking market risk may be muted, they should look for new ways to boost portfolio returns. 

Back to the big picture. Taking our market views above and scoring them by how likely and to what magnitude we think they might move versus expectations, we can factor in the macro sensitivities discussed above to create an asset class-level score²:

As a single score, we see a strong fundamental setup for PE in particular, and are less positive on private credit. 

There is, of course, nuance that a single signal cannot communicate. There are areas in private credit we are quite excited about. But at the overall level, too much capital is flowing into too few loans and rates that do not compensate for the risk. On the flip side, while we remain very bullish on early-stage VC, given specific themes we think are shaping up to transform the economy rather than the macro environment, there is hype in generative AI that needs to be approached with caution.

Outlook for different macro drivers

In part 2 of our outlook, coming later this week, we’ll dive into these idiosyncratic factors - i.e., themes and ideas that could create alpha opportunities - so that we can wed the top-down and bottom-up to form a comprehensive view of the most exciting places to deploy capital in 2025.

But before we do that, it is important to explain exactly how we arrived at our fundamental macro signals, by looking at our expectations for growth, inflation, interest rates, capital availability, and risk premiums.

Growth: We are far from perma-bulls, but we expect nominal growth to increase, and likely beat expectations. There is sensitivity to Fed action, but increased capital expenditures (capex) in the US, rising deal activity, and slightly more accommodative interest rates should be major drivers of GDP in the year to come. There are question marks around consumer confidence, though these appear to be receding, with the main issue on the consumer side being a sustained slump in mortgage and household sale activity, which is a major driver of wealth creation and spending. The international growth picture is less rosy, so all else equal we are bullish on the more domestically focused private markets versus internationally exposed large caps.

Jacob Miller explains why private firms may weather tariffs better than large public companies

While rates are weighing on mortgages, consumer confidence is picking up, and consumer spending remains robust (see chart).

Business confidence has rebounded sharply, and tariffs and a more accommodative Federal Trade Commission could spur borrowing for acquisitions and capex (see chart).

Inflation: Likely higher for longer. Trade tensions make goods more expensive, and capex on home soil is inflationary: Companies will bid for raw materials and the workers to turn those materials into plant and property. However, we do not see major disruptions as likely this year. With current credit creation relatively muted, inflation may remain above 2% for longer, though a major increase from here is not expected. 

Interest rates: Despite a fairly optimistic picture for growth and directionally more risk to the upside for inflation, the market is pricing more cuts in for 2025, as shown with the forward path of the SOFR curve below. Looking two years out, the yield curve has normalized, but the market is still pricing in easier policy in the short term. Expectations have shifted from more dramatic rate cuts, but no cuts or a rise in the short rate in 2025 would surprise markets, impacting all assets.

Looking long term, rates are still near cycle highs, though relatively normal for history. Break-even inflation is around 2.4%, leaving real yields at their highest since the GFC (see chart). One of the more material potential headwinds to growth is whether businesses and consumers can stomach interest rates this high with debt levels where they are. The level of real growth will determine the impact of the high cost of debt service in 2025.

Given this refinancing risk, we also think that spreads are priced low. Reshoring and inflation will boost profits for some companies, but hurt margins for many more, which will make it hard to grow the bottom line faster than real debt servicing costs (see chart, more detail in “Risk premiums” below).

Capital availability: Likely to expand. We expect deregulation, both of capital markets and the M&A market, in the near future. Both of these should re-open capital markets and increase deal activity, leading to exits, liquidity events, and more places to deploy dry powder. 

Banks have shifted from tightening standards to loosening them for businesses (see chart).

Risk premiums: The world is volatile right now, especially on the global stage. This uncertainty makes it harder to plan and may mute long-term valuations of all assets, offsetting our generally positive growth expectations. It is also worth noting we are starting from a compressed level - valuations are high and risk measures are low (see chart). There is a greater chance that the market is undervaluing these risks than overvaluing them.

In part two of our Outlook, we will complement the top-down view of part one with a bottom-up look at interesting idiosyncratic themes likely to play out in 2025, and tactical tilts by which to benefit from them in private markets.