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Written by: Rasib Bhanji | AGF Investments
Anthropic, a privately owned artificial intelligence (AI) firm, sent shockwaves through equity markets earlier this month when it released new, industry-specific AI tools and debuted the latest upgrade of its AI model, known as Claude Opus 4.6. Software stocks were especially hard hit on fears that these types of advances in AI technology could threaten the viability of traditional enterprise software-as-a-service (SaaS) companies over time, yet software wasn’t the only market segment impacted. The fallout was also felt across several other sectors and industries, including the alternative asset management space, which is heavily invested in the software industry and therefore exposed to any potential negative consequence of AI disruption.
How negative? That may largely depend not only on how quickly AI can displace existing software workflows, but also on the degree to which an individual alternative asset manager has exposure to software companies whose workflows are most vulnerable to being displaced.
We believe—along with many others—that most software companies are relatively safe from experiencing a sudden drop in revenue or profits, partly because of how entrenched some of them are in the workflows of their users, but also due to existing regulatory barriers and cyber-security insurance coverage that won’t be easily circumvented. For example, companies looking to supplant existing software workflows with AI-based workflows will need the blessings of regulators and a thorough compliance and security check to ensure proprietary and highly classified data isn’t exposed to leaks or hacks.
Still, even if software earnings are resilient in the very near term, investors may be right to question the high valuation multiples that software stocks have typically traded, supported by moat-like characteristics such as recurring revenues, sticky margins and operating leverage. Indeed, that may be the reason why so many alternative asset managers have viewed software as an attractive area for investment over time. But now the long-term sustainability of these characteristics is under scrutiny, and the ongoing debate is, “How much should I pay for a business that may soon lose its competitive advantage?”
Of course, alternative asset managers that are potentially the most susceptible to this re-rating of valuation multiples are those with the most exposure to software companies. According to Wolfe research, business development companies (BDCs)— which are mostly publicly traded closed-end funds that provide debt financing to mid-sized firms and provide daily liquidity to investors—have roughly 25% of their portfolios concentrated in software and information technology names. Meanwhile, broader-based alternative managers—which typically manage more asset-diverse and less liquid funds—have between 16% and 20% exposure.
Despite the obvious potential risks of these large concentrations, including private credit defaults, slowdowns in private equity exits, and an inability to maintain double-digit asset growth, it’s interesting to note that recent results from many alternative managers have been relatively positive in this respect. In fact, management teams at several firms have indicated that actual software exposure is well below current estimates and falls in a range between high single and low double digits. Moreover, many managers are continuing to deliver strong revenue and EBITDA growth as well as margin expansion, while noting in some instances that lending to software companies was done at loan-to-values that range close to 30%. That gives them a significant equity cushion to absorb any impairments.
Ultimately, it’s hard to deny the impact that ongoing advancements in AI tools and models is going to have on traditional enterprise software companies and, by extension, the alternative asset managers who invest in them. In this climate, it may take a few quarters before investor confidence is restored—and perhaps recalibrated for a new reality—but we believe the recent pullback is only temporary for those companies that report continued financial resilience over time.