The second quarter of 2025 turned out to be a memorable one for US equity investors. The Trump administration rolled out “reciprocal” tariffs on the second day of the quarter and triggered a stunning 11.2% freefall in the S&P 500 in just four trading sessions. This brought total losses in the S&P 500 to 18.7% from the record highs just seven weeks earlier. The market rebounded though as implementation of the unexpectedly high tariff rates was paused and an effort to negotiate trade deals began. It took just 11 weeks for the US equity market to return to record highs. At the same time, uncertainty surrounding trade policy lingers and has been compounded by a lack of clarity on the path of both fiscal and monetary policy as well as continued geopolitical disruption. By the end of the quarter, market valuations consistent with a worrying level of complacency had returned despite the broad array of risks confronting US equity investors. 

While the most aggressive tariff rates have been put on hold for the time being, a 10% tariff is in place on all imported goods with additional product- and/or country-specific levees layered on top of this. Regardless of the politics of the situation, this shift in supply-chain dynamics has real consequences for the earnings potential of US corporations and stock market valuations. We have asserted for a number of years that a bias toward quality companies with pricing power is required given the risk of stubbornly elevated inflation, and developments in the current quarter have increased our conviction in this theme.

The combination of the new tariff regime and the OBBB that encompasses many of the administration’s domestic priorities has also put the Fed in an uncomfortable position. It now faces the unenviable task of estimating the net effect of a myriad of tariff increases along with tax and spending cuts. The daunting nature of the task and lack of historical precedent has left the Fed in “wait and see” mode, which is understandable but challenging for equity investors. Ultimately, equities are worth the discounted value of future cash flows to shareholders, and as we saw in 2022, the valuation of equities (and particularly growth equities where cash flows are far off in the future) is inherently tied to interest rates. Uncertainty surrounding the path of fiscal and monetary policy makes today’s elevated valuations particularly challenging. 

US equity valuations have returned to lofty levels as illustrated by the chart below.  The price/earnings ratio (a measure of how much shareholders pay per share of corporate earnings) is now more than 26% above the 30-year median. Some of the valuation premium reflects ongoing earnings growth despite a slowing economic backdrop. Corporate earnings last quarter remained robust overall and were bolstered by the ongoing investment cycle in Artificial Intelligence (along with the associated disinflationary and profit margin-boosting implications of this trend). At this point, valuations remain a risk factor that could exacerbate a market downturn, but we have not seen the type of reckless financing and irrational valuations consistent with a bubble that could undermine the overall market. The result is that we expect the earnings growth that has driven US equity ascension in recent years to continue, with the caveat that the relatively narrow market leadership that reasserted itself this quarter can’t go on forever. Ultimately, we’ll need broad participation for the stock market’s advance to prove durable. 

In conclusion, while recent resiliency is comforting, it is inconsistent with the risks to the economic outlook posed by trade disputes, interest rate uncertainty, and geopolitical strife. The earnings growth that drove our optimism at the beginning of the year still seems to be intact, but catalysts for volatility have multiplied significantly.  Our base case remains that US equities can make further progress, but we now expect more volatility along the way and the range of potential outcomes is much wider than originally expected. As a result, we remain fully invested in US equities with a tilt toward higher quality equities that seem likely to survive and even thrive regardless of the various challenges that arise in coming months and quarters.

Global equity markets staged a powerful rebound in the second quarter of 2025, navigating a complex macro environment shaped by persistent tariff uncertainties and escalating geopolitical tensions in the Middle East. The MSCI All Country World Index posted an impressive gain of 11.6% for the quarter, marking one of the strongest quarterly performances in recent years. This rally was underpinned by renewed investor confidence following signs of resilience in corporate fundamentals, as companies across multiple sectors in multiple countries delivered stronger-than-expected earnings despite a volatile policy environment.

International equities extended their relative outperformance in the quarter, with the MSCI World ex-US Index rising 12.3% versus a 10.9% gain in the S&P 500. This performance was largely driven by a sustained decline in the US dollar, which depreciated 6.6% during the quarter (10.8% in the first half) and reached a three-year low in late June amid rising fiscal concerns, elevated Treasury yields, and growing policy uncertainty. The resulting shift in global capital flows favored international markets, where comparatively attractive valuations and an improving corporate outlook prompted investors to diversify away from US-centric exposures.

Among developed markets, Europe and Japan were standout performers. The MSCI Europe Index climbed 11.8% in the quarter on the back of increasingly pro-growth policy momentum. The European Central Bank has now implemented eight consecutive rate cuts since 2024, bringing its deposit rate to 2.0%, while fiscal expansion—particularly in infrastructure and defense—continues to support corporate earnings. This coordinated policy mix is helping to cushion external shocks and supports a constructive view on European equities. In Japan, equities advanced 11.2% in the quarter, reversing Q1 losses, as improving corporate profitability, broad-based margin expansion, and ongoing governance reforms attracted renewed foreign investor interest. The market is undergoing a structural re-rating higher, with stronger capital discipline and higher shareholder returns forming the foundation for longer-term performance. While headline risks from yen volatility and US trade dynamics persist, Japan remains a favored allocation within developed markets.

Emerging markets also delivered strong relative performance in the quarter, with the MSCI Emerging Markets Index gaining 12.2%. India was among the stronger performers, with the MSCI India Index up 9.7%, bolstered by a manufacturing PMI surge to 58.4 in June and expectations for 6.2% GDP growth in 2025, accelerating even further in 2026. Earnings growth remains robust, supported by strong domestic demand and sustained infrastructure investment. In contrast, Chinese equities posted only modest gains in the quarter, with the MSCI China Index rising only 2.1%. Investor sentiment remained cautious amid deflationary concerns, renewed tariff pressures, and longstanding structural headwinds, including demographic decline, property market weakness, and subdued consumer spending. That said, China’s domestic tech sector has shown signs of revival, and targeted policy support could offer selective opportunities.

Looking ahead, we remain constructive on international equities. Relative earnings revisions outside the US continue to improve as shown in the chart below, valuations remain attractive, and many international central banks are now supporting growth through accommodative policy. While risks tied to geopolitics, uneven recovery paths, and external trade tensions remain, we continue to favor markets with strong domestic demand, improving visibility on earnings growth, and credible policy frameworks. In this environment, we advocate for a selective, diversified approach with a focus on quality and resilience.

Within fixed income markets, tariff policy was the key driving force in the second quarter, causing dramatic intra-month swings in both credit spreads and interest rates. The 10-Year Treasury yield started the quarter at 4.17% but dropped all the way to 3.99% three trading sessions later, as President Trump unveiled sweeping tariffs on most imported goods. The initial move in interest rates reflected a rush to the safety and liquidity of US Treasuries as the market reflected negative implications for economic growth. Only days later the narrative changed, when the inflationary impact of tariffs and reduced confidence in US assets became the dominant themes. By April 11th, the 10-Year Treasury had spiked to 4.50% and the US dollar had plummeted. During this period, high-yield credit spreads, a key indicator of market stress, also reflected investors’ concerns: after starting the quarter at a spread of +345 basis points (3.45%), the Bloomberg US Corporate High Yield Index spiked to +453 basis points (4.53%), the highest level since the middle of 2023. When the date for enforcing most tariffs was subsequently delayed, markets rebounded quickly, credit spreads tightened, and interest rate volatility faded.

Given the intra-quarter volatility, it is remarkable that credit spreads ended the quarter tighter than where they started it. This measure, however, may understate risks in the market. At a current +281 basis point (2.81%) spread over a comparable-maturity US Treasury, high-yield spreads have only been tighter about 4% of the time in the last ten years. Trade policy, tariffs, budget deficits, and geopolitical unrest are all risks that concern us, even as the strong fundamentals of the corporate and municipal sectors are reassuring. Specifically, corporate financial leverage remains close to longer-term medians as most companies continue to manage their balance sheets conservatively. The New York Federal Reserve also produces a Corporate Bond Market Distress Index1 (CMDI), which quantifies how smoothly credit markets are functioning. The investment-grade portion of this index is at its 14th percentile historical value, while the high-yield portion of this index is at its 22nd percentile historical value, meaning stress is low and both investment grade and high-yield credit markets are transacting in an orderly manner.

There is a growing list of factors that are likely to affect interest rates in the second half of 2025, and investors are moving forward with one eye focused on the health of the US economy and one eye on government policy. In the near term, the OBBB appears likely to add to the fiscal deficit, which may have the effect of driving rates higher. Tariff policy and the Trump administration’s America-first approach may lead to lower marginal foreign demand for US Treasuries, which could also increase interest rates. Factors that could cause interest rates to drop include fading inflation and gradually slowing US economic growth. Amidst the crosscurrents of tariff policy, budget wrangling, and economic data, the Fed has avoided committing to a course of action. Despite pressure to cut rates from Trump, Fed Chairman Jerome Powell remains committed to a wait-and-see approach in an environment where tariff policy is uncertain. In fact, Powell recently suggested that the Fed would likely have already reduced rates this year if it were not for plans to impose substantial tariffs on imported goods. Futures markets are currently forecasting that two or three 0.25% cuts to the Fed Funds rate will still occur in 2025 as the Fed gains more clarity.

Our fixed income themes for 2025 remain consistent heading into the second half of 2025: short portfolio duration, inflation protection, and caution and selectivity within corporate credit. Given recent interest rate volatility and the market risks that loom under the market’s calm surface, we are comfortable keeping fixed income portfolios defensive. Ultimately, we expect that uncertainty and volatility will be the norm in the second half of the year, and we expect to parse through conflicting market signals while enacting client portfolio strategy. 

Tax deferral: A 1031 exchange transaction can be an effective way to defer capital gains tax due on the sale of an investment or business property.  A 1031 exchange refers to like-kind exchanges of real estate under Internal Revenue Code Section 1031 established by the IRS.  While personal and vacation residences are not eligible, the “like-kind” label is fairly flexible, meaning an investor can exchange any investment property for another, ranging from apartment housing to undeveloped land or something else.

Regardless of the investment performance of the property one chooses to swap into, there is a significant advantage in deferring what is often one of a taxable investor’s biggest costs: taxes.  Here is a simple example:

Based on the above it’s easy to see the growing impact taxes can have on an investment.  In this simple example, an investor who used a 1031 exchange option would have $214,901.72 more than one who did not, assuming equal rates of return and no leverage.

Logistics: Before listing a property, an investor must engage a Qualified Intermediary (QI) who facilitates the entire exchange process. The QI cannot be a relative, employee, or someone who has provided services to the investor in the past two years. The investor then signs an Exchange Agreement that assigns contract rights to the QI.

In the event an investor is not simultaneously swapping an investment property with another investor, timelines matter.  Upon selling a property, the investor has 45 days to identify a new property and then an additional 135 days to complete the exchange and close on the new property.

A successful 1031 exchange requires coordination among several professionals: a QI (mandatory), real estate attorneys, CPAs for tax guidance, real estate agents, and settlement agents. The QI industry is unregulated, making careful selection essential for fund security and proper execution.

UPREIT & Diversification: One avenue growing in popularity is doing an exchange through an UPREIT (Umbrella Partnership Real Estate Investment Trust), also referred to as a 1031/721 exchange. In this case, the UPREIT eventually converts into shares of a diversified private REIT. This can be a useful tool for investors thinking of the next generation and the cost basis step-up they will eventually receive.

Essentially, the investor performs two sequential exchanges. The investor typically exchanges into a property the REIT manager has already identified as an investment target (“Property B”) via 1031 exchange.  Property B is then held for 12-24 months inside of a Delaware Statutory Trust (DST) to satisfy IRS requirements and demonstrate investment intent. From there, the investor exchanges their interests in the DST for an interest in the UPREIT via a 721 exchange.

At this point, the investor owns shares in an UPREIT investment vehicle, which is a larger, more diversified and professionally managed portfolio of institutional real estate.  This structure inherently offers greater diversification across property types, geographic markets, and tenant exposures than owning a single asset.

However, to continue to defer the capital gains tax, investors must hold off on converting their UPREIT units to shares in the predetermined private REIT, which is the endpoint destination.

Conclusion: As with many things, it helps to start with the end in mind.  Understanding the desired endpoint will help guide an investor toward an appropriate solution.  An investor who prefers to have exposure to single properties of their own choice, is a good fit for a traditional 1031 exchange.  An investor who prefers to outsource property management and move into a more diversified, institutional-grade portfolio of real estate, is a better fit for a 1031/721 exchange into an UPREIT.

Taking advantage of these opportunities to defer capital gains can be worth the extra effort and administrative burden, especially when factoring in the future compounding of untaxed gains.

Semi-Liquid Alternatives

In the last decade, the private market has expanded from $4 trillion to $20 trillion. These flows were driven by the widespread adoption of the “Endowment Model” of investing by institutions: a style pioneered in the early 1980s that emphasizes long-term growth through diversification and a large allocation to alternatives.

Using data from the past 20 years, the allocation to alternatives has been justified by compelling annualized outperformance relative to public counterparts (private equity +400 bps or 4% higher[1], private credit +573 bps or 5.73% higher[2] and private real estate +100 bps or 1% higher[3]) with substantially less volatility (55-65% less for private equity and real estate) and lower relative drawdowns.

High minimums, investor eligibility requirements, long investment horizons, K-1 tax reporting, and complex operational considerations common in private placements kept individual investors out of private investments.

However, the alternatives industry sought to participate in the growth in assets in the wealth management industry and innovated new structures to simplify access, eligibility, custody, tax reporting, and operational requirements for individual investors and the wealth management industry. In the table below, we compare typical characteristics of semi-liquid alternative funds (Interval Funds, Tender Funds and Non-Traded REITs/BDCs) to those of private investments. According to Morningstar, assets in semi-liquid funds that offer exposure to alternatives have grown from $200 billion in 2022 to over $350 billion today, and we believe this trend has ample long-term support to continue.

Based on flows and new launches, Interval Funds appear to be the preferred vehicle for new product development, with approximately 20 new funds launched in 2025 as compared to 27 in all of 2024. For retail investors and wealth management firms, these structures greatly simplify key pain points in accessing alternatives. While these investment structures bring clear benefits in terms of enhanced returns and diversification, they come with some drawbacks that must be considered to determine client-specific appropriateness and sizing.

Recent Alternative Performance Review

Semi-liquid alternative funds can broadly be bucketed as follows: Private Credit, Private Equity, and Real Estate. Secondaries, growth equity, and venture capital are sub-strategies within private equity and are reported in the larger category. Infrastructure is a nascent asset class within semi-liquid structures so we will not discuss its performance at this juncture. Generically, these funds have varying return targets based on their risk-taking and illiquidity profiles. In the current market, those targets are approximately 9-11% for private credit, 12%+ for private equity and 8-10% for real estate. YTD through May (semi-liquid performance reporting lags that of public markets) strategy performance follows:

Private Credit: Below Target Performance – Returns for the manager universe are trending down closer to 8% for 2025 and managers are increasingly deploying strategies to extend the runway for cash-strapped borrowers (40% of borrowers were cash-flow negative in 4Q24, up from ~25% in 4Q21). An increase in payment in kind (PIK – cash interest payments substituted for IOUs to be paid at maturity), and out-of-court restructurings point to lower returns ahead. Middle market direct lending strategies are the most at risk, while asset-backed lending strategies appear insulated.

Private Equity: On/Above Target Performance – Performance has generally been strong but there are material differences between funds heavily investing in secondaries and those that are not. While private equity investments are generally marked up quarterly or annually based on EBITDA changes, the largest increases typically occur when businesses are exited after multiple years of ownership. While secondaries buyers experience these same dynamics at the company level, they typically benefit from purchases that are made at a discount to NAV that provide an immediate pop to performance. With relatively young portfolios and strong asset growth, some vehicles have generated returns (20-30%+) that we believe to be unsustainable over the long-term and have pulled up the average.

Real Estate: Below Target Performance – Semi-liquid real estate funds have largely cleared the outflow and redemption gate issues of late-2022 to early-2024. Aside from positive flow dynamics and relatively low leverage, with typical cap rates across asset types just over 5%, material net operating income (NOI) growth needs to occur for managers to be able to generate on target returns. At this time, we see the green shoots of a more positive trend (occupancy ex-office is generally high) but we are still waiting to see rents increase more aggressively and for monthly performance to pick up.

[1] Pitchbook Global Private Equity benchmark vs S&P 500 for January 2005-December 2024

[2] Pitchbook Global Private Debt benchmark vs Bloomberg Barclays US Aggregate index for January 2005-December 2024

[3] Pitchbook Global Real Estate benchmark vs S&P United States REIT Index

for January 2005-December 2024

Sustainable Investing

​

After many weeks of negotiations and adjustments in the House and Senate, President Trump’s One Big Beautiful Bill (OBBB) has been passed. This legislation is significant in many ways, with some of the broader economic and market considerations covered in our monthly blog. With regard to the clean energy-related provisions of the IRA, the adjustments in the OBBB are big but certainly not beautiful. As written, the bill will likely result in lower levels of clean energy generation growth, weakened domestic supply chains, and over time, higher power prices in the US.  For sustainable investors there are a few silver linings on the longer path forward toward decarbonization.

The IRA, passed in 2022, was centered on incentives to create a lower carbon economy in the US through tax credits and low-cost financing. As discussed in our Q3 2022 letter, the IRA put in place long-term incentives to build all forms of clean energy, from wind and solar to geothermal and nuclear; it incentivized the creation and growth of domestic supply chains across critical minerals and all meaningful components required to lead in decarbonization across energy and transportation systems; it created incentives to shift toward electrified transportation. These incentive programs represented the most significant actions toward lower carbon economic growth ever undertaken.

As we noted in our Q3 2023 follow-up, capital investment and job creation after just one year were significant.  Growth across the US supported by the IRA continued broadly, though more concentrated in Republican-leaning states with business-friendly policies among other factors. The IRA created a strategic roadmap to build domestic industries that could compete with China in the race to decarbonize and attempt to avoid the worst-case outcomes of climate change. It was an investment in a more sustainable future. Investing in anything new requires an understanding that payback only happens over time as products and industries get to scale and costs come down.  With the changes in the final OBBB, achieving scale is now clearly at risk.

There are a number of important changes to the IRA outlined in the latest version of the Senate bill. The most important adjustments in the 1,000+ page bill include:

• Utility-scale solar and wind power projects
  • A 12-month window to commence construction to capture a 4-year safe harbor position. This means investing at least 5% of project costs based on existing guidance. Projects meeting these guidelines will have access to investment and production tax credits through the early 2030s, though will have to meet restrictions related to content from Foreign Entities of Concern (FEOC)
  • Projects started after the 12-month window must be placed in service (i.e., connected and generating power) by the end of 2027 to capture credits. Otherwise, credits expire on 12/31/27. These projects must also meet FEOC requirements
• Residential solar, other clean-energy, and energy efficiency credits expire at the end of 2025, though solar leases through commercial entities have two additional years of eligibility to capture the investment tax credit
• Advanced manufacturing credits supporting supply chain development for solar and battery components run through 2029 and phase down through 2032. Wind credits expire at the end of 2027. Critical minerals credits run through 2033. In all cases, there are more complex and stringent domestic content and FEOC rules as well as stipulations related to vertically integrated manufacturing and sales to unrelated parties
• Electric vehicle credits for consumer purchases and commercial leases end on September 30, 2025. There is a provision to eliminate penalties for noncompliance with fuel economy standards for automakers

While the bill has been signed, many uncertainties remain around Treasury and IRS guidance related to safe harboring, FEOC provisions, and other factors. This uncertainty will weigh on large solar and wind development as financing will have to adjust to higher levels of risk. The bill is a clear negative for consumers interested in electric vehicles and home energy efficiency and savings.

From a US power generation perspective, we expect a rush to safe harbor solar and wind projects followed by a deceleration in new project activity. While this provides a window to complete projects, execution risks will be much higher going forward, meaning smaller developers will likely struggle.  Relative to prior expectations, growth in new clean energy supply will be lower and power prices will have to rise as ability to capture credits fades after 12 months. This dynamic could not come at a worse time for the sustainable energy industry and for power supply in general.

Power demand in the US is inflecting higher after more than 15 years of flat demand, as noted in our Q2 2024 letter.  There are many drivers of this, including reshoring and industrialization in the US as well as automation and efficiency improvements in existing commercial and industrial facilities.  While these factors are important, the most significant driver is directly related to America’s lead in technology, Artificial Intelligence (AI) development.  Data center development to train and run AI models, that enable increasingly broad use cases, are very energy intensive. A recent update from McKinsey illustrates the inflection in power demand, a trend that is just starting.

Ramping power demand growth is why renewables, in particular solar, wind, and battery storage, are so important in the short-term regardless of climate change considerations. Renewable energy projects can be built in 12-24 months, while it takes 3-5 years to build a new natural gas combined cycle power plant. This is a dynamic the CEOs of the largest utilities have been very vocal about recently.  The lead times for natural gas are more structural given the complexity of projects and availability of equipment.  Changes to the IRA in the OBBB hinder budding domestic supply chains and introduce new material risks to project development relative to otherwise available equipment and capacity to build infrastructure. This is an active decision to have less new power supply all else equal, potentially disadvantaging the US relative to China in the race to develop AI.

Our Q3 2024 letter covered the insatiable appetite for power of the “hyperscalers” developing AI. As in all commodity markets, when demand growth is not sufficiently met with new supply, the result is higher prices. The hyperscalers have shown that access is more important than cost in this strategic race. Our expectation is that power prices will rise over the next few years, which will incentivize continued renewable energy growth, development of energy storage, and development of other types of new power supply. Consumers should expect rising prices.  Investors should expect pockets of opportunity.

From the summary above, it should be clear that production and supply chain activity across electric vehicles, wind, and eventually solar will be under pressure. Growth will slow. Residential solar and other consumer activity will likely move back to become niche markets. Other parts of the broader clean-tech market are in more advantaged positions with more favorable treatment in the OBBB and likely tailwinds from higher power prices.

The final Senate version of the OBBB clearly favors clean baseload and dispatchable energy, including battery storage, geothermal, and nuclear. These three technologies retain access to investment and production tax credits through 2032 before they step down. Manufacturers and developers will have to manage various FEOC rules, domestic content requirements, and fuel restrictions for nuclear. That said, these will be seen as advantaged clean energy technologies with tailwinds relative to other areas.  Storage may be the most important near-term given industry development in recent years enabling capacity to deploy.

Higher power prices should also be positive for niche solutions like fuel cells, a technology that regained access to tax credits in the final version, an unexpected positive surprise.  More broadly, grid management and energy efficiency technologies and companies will likely see tailwinds as power demand exceeds supply.

While the OBBB represents a step backward on the path to a more sustainable future, economic and market pricing signals will enable some level of continued clean energy growth, and a broader range of solutions may play a larger role in the future.

Disclosure