Should alternative asset managers be trading like software?

Episode Summary

Executive Summary: The episode examines why alternative asset managers—especially those tied to private credit and BDCs—have sold off sharply amid AI-driven fears for software-heavy portfolios. Ben argues the drawdown is partly justified by lower growth and valuation risk, but not to the extent implied by a 25%+ drop, noting strong credit performance, limited fundamental deterioration, and continued demand for private equity and insurance channels.

Main Topics: AI disruption and software exposure in private markets (Priority: 5/5): The hosts discuss how Anthropic-related AI developments intensified concern that software and tech-enabled portfolio companies may face revenue and cash-flow pressure, creating terminal value risk for private credit and private equity assets. BDC sell-off as the focal point of retail fear (Priority: 5/5): Business development companies are highlighted as the most visible and retail-facing vehicles for private credit, making them the center of the market's reaction because of their meaningful software exposure and leverage. Whether the market decline is justified by fundamentals (Priority: 4/5): Brad argues the decline in alt managers may be rational given software concentration and leverage, while Ben counters that current credit metrics, non-accruals, and loan buffers do not yet support a doomsday scenario. Valuation mechanics for alternative asset managers (Priority: 4/5): The discussion explains that investors value fee-related earnings at higher multiples than other fee streams, but the complexity and cyclicality of alt-manager earnings make it hard to identify a floor or call the stocks cheap. Private equity and insurance as offsetting growth channels (Priority: 3/5): Beyond BDCs, the conversation covers private equity fundraising and insurance AUM as other growth engines, with Ben noting that software exposure is lower in firm-wide PE books and insurers hold more senior, better-rated assets. Differentiation after indiscriminate selling (Priority: 3/5): Both speakers agree that even if the worst-case scenario does not materialize, the broad sell-off likely creates winners and losers within the sector based on true exposure, portfolio quality, and fundraising strength.

Key Arguments: AI adoption is a real risk for software-heavy portfolio companies, but it is not obvious that most mission-critical software spending will disappear quickly. Alternative asset managers were sold off indiscriminately, even where direct BDC exposure was limited. BDCs matter disproportionately because they are retail-facing, leveraged, and generate meaningful fee revenue. Current credit performance remains relatively healthy, with low defaults and non-accruals, which argues against an existential credit event. Many software loans in BDCs have lower loan-to-value ratios than the average loan, giving them more equity cushion. The drop in valuations is also about growth expectations: BDC and private credit asset accumulation may slow, reducing future fee-related earnings. Fee-related earnings deserve high valuation multiples because they are more predictable than performance fees, so slowing growth can materially hit stock prices. Private equity can offset weak positions with strong performers across the portfolio, unlike a pure credit book where outcomes are more binary. Insurance AUM is an important growth channel, but the underlying portfolios are generally more senior, investment-grade, and less exposed to software risk. The sell-off may reflect a difficult cyclical backdrop and valuation uncertainty as much as it reflects portfolio fundamentals.

Data Points: Stock drawdown in alternative asset managers: 25%+ - Brad describes the move lower in alt-manager equities as severe, similar to software-sector declines. Software exposure in BDC collateral: ~20% - Ben cites average BDC loan collateral exposure to software-related borrowers. Loan-to-value on software loans: ~30% - Ben says software loans in BDCs tend to have lower LTVs than the average loan. Average loan-to-value: ~40% - Used as a benchmark versus software loan LTVs. Private equity software exposure across firm-wide portfolios: ~10% to 11% - Ben says the highest firm-wide software exposures across coverage are around this range. Tech-oriented manager private equity book software exposure: ~20% of the PE book - Higher software concentration exists at tech-oriented managers, but still not typically firm-wide. Private BDC contribution to last year's fee revenues: 5% to 20% - Ben notes private BDCs can contribute a significant share of fee revenue. Valuation multiple for fee-related earnings: 20x to 30x - Ben explains that investors pay high multiples for predictable fee-related earnings. Valuation multiple for other fee streams: 8x to 10x - Used as a comparison to fee-related earnings multiples. Leverage buyout debt multiples: 5x to 7x EBITDA - Brad references the capital structures many software companies entered through PE deals. Non-traded REIT NAV decline peak-to-trough: ~20% - Ben uses this as precedent for a sector drawdown without collapse to zero. Private credit / BDC NAV sell-off in prior fall: 10% to 20% of NAV - Brad references prior negative headlines and pricing pressure despite limited fundamental change.

Pivotal Quotes: "“Software is not dead, just changing, and widespread exposure to software creates uncertainty.”" — Transcript closing note / research reference: Summarizes the core investment message and the AI/software risk framing. "“I actually think you need some of the draconian scenarios to be true before I worry about the BDCs.”" — Ben Budish: Ben argues the market has overreacted relative to current credit fundamentals. "“It’s not just about growth, it’s also about what you own.”" — Brad Rogoff: Brad frames the valuation debate around portfolio quality and underlying asset exposure.

Implications: Investors should separate real AI/software exposure from headline-driven panic. Near-term growth and fee accruals may slow, but strong credit metrics and diversified fee streams suggest the sector’s sell-off may be overdone in places, creating dispersion and potential selective opportunities.