Beware the AI awakening

The tech sector took a sharp hit yesterday as investors grappled with a familiar fear in a new costume: AI is beginning to undercut core software businesses.

Anthropic’s release of new tools designed to automate legal work spooked markets and sparked a selloff, but panic quickly spread beyond legal tech. Financial and data software names also slid as investors questioned how defensible “must-have” platforms really are in an AI-first world.

But AI anxiety isn’t contained to software stocks—it’s spilling into private markets, where exposure is deeper, exits are slower, and the pain of a tech downturn could be much worse.

Private markets feel the shock

Alternative managers sold off yesterday: Blackstone and Apollo Global Management each fell about 5%, while KKR and Blue Owl Capital both dropped around 10%, reflecting investor concerns over their software-heavy portfolios.

For private equity, the risk is structural. Over the past decade, buyers poured more than $440 billion into deals, betting products would stay relevant long enough for leverage and margin expansion to pay off. But AI compresses that timeline, raising the odds that disruption arrives before returns are fully realized.

For private credit, the pressure is more immediate. Software is the single largest sector exposure for business development companies, or BDCs, accounting for roughly 20% of portfolios. If AI begins to erode cash flows faster than borrowers can adapt, defaults could rise quickly. In fact, UBS estimates US private credit default rates could climb as high as 13% under an “aggressive” disruption scenario, Bloomberg reports.

Investors are already pulling back: Blue Owl’s BDC recently lifted withdrawal limits well above normal levels to 17%, and disclosed that investors redeemed more than 15% of assets—an early sign that concerns over AI risk are translating into real capital flight.

Time for an AI reset

AI-driven disruption in software is starting to look less like a sector wobble and more like a market-wide reset, as investors flee growth and turn to the safety of good ol’-fashioned value investments.

Since early November, the Russell 1000 Value Index has gained 8.6%, beating the Russell 1000 Growth Index by 14 percentage points, a divergence last seen during the 2022 bear market and the early phase of the dot-com unwind.

Private capital has been happy to fund tech’s multi-year rally, reaping rewards from nonstop growth. But as it becomes clearer that AI isn’t going to lift all tech stocks equally, investors are rotating out of growth and into value—which means that, for once, private equity may be left holding the bag.—SY