Following the software sell-off, panic appears to have eased, with a rebound now visible in parts of the market, so where are private credit investors focusing their efforts?
The future viability of software as an industry – and as an investment opportunity – was called into question earlier this year after artificial intelligence (AI) developer Anthropic unveiled tools seen as capable of disrupting large parts of the sector.
The breakthrough initially rattled markets, triggering a sell-off in software companies which fed through into private credit, with the sector being favoured by lenders, hitting US-listed private credit vehicles.
However, several months on, some of the sector has recovered. Software company Snowflake, for example, saw a sharp sell-off between February and April, with its share price at one point more than 50 per cent below levels a year earlier.
By June, the company had staged a strong rebound, recovering much of those losses after announcing increased investment in AI, with investors now expecting it to benefit from AI-driven demand.
“There was a bit of panic early on, but you’ve seen a big rebound,” Anant Kumar, global investment strategist at Benefit Street Partners, told Alternative Credit Investor. “Software sold off massively in quarter one, but if you look at say the IGV ETF, it has recovered a lot of its losses.”
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In regard to software companies, Kumar said that there are parts of the market that are “truly doomed”, some that will be disrupted in a manageable way and some that may benefit from AI. A nuance which has not been fully priced in.
The idea that some software companies may benefit from AI has also been overlooked, according to Jakob Schramm, head of private credit at Golding Capital Partners, as the technology can enhance rather than replace existing models.
“AI is also a chance for a lot of software companies,” he told ACI.
Golding has a software exposure of around 10 to 15 per cent, which Schramm said is unlikely to change materially. Exposure is focused on lower mid-market and mid-market firms rather than large-cap names with higher headline risk.
He added that the most resilient businesses are those that are vertically integrated, data-rich and embedded in customer systems.
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Elsewhere, Jason Georgatos, president of $1bn (£755m) Partners for Growth (PFG), said the firm’s software exposure is also around 15 per cent, but cautioned that PFG is becoming more selective, while still continuing to back SaaS companies.
“We are still investing in SaaS companies despite the potential for disruption, we think there is still a lot of good reasons to back certain SaaS companies,” he told ACI.
However, Georgatos described software portfolio construction as a “constant debate”, with preference for regulated and defensive areas such as healthcare and financial services, where switching costs are high.
He warned that more commoditised SaaS and dashboard-style tools could be more exposed to AI substitution.
Meanwhile, Solomon Nevins, partner at research platform The Fund Review, said private credit’s exposure to software is unlikely to be “terminal” for the asset class, but response to disruption matters. He pointed to IT and communications services as the most at threat to AI disruption, representing 22 per cent of semi-liquid private credit funds on average.
Overall, Nevins stated that he has seen a gradual shift away from IT exposure within private credit, but also reclassification of some holdings.
This article originally appeared in the July edition of the Alternative Credit Investor magazine, to view the issue click here.
