By Pete Robinson, Head of Investment Strategy, Challenger Investment Management
Many will have seen the recent news regarding US Private Credit exposure to the software sector and the flow on concerns regarding the impact of AI on software businesses. Investor fears have centred around those managers who are most exposed with some holding software exposure well in excess of 20 percent.
Given the volume of reporting, and the speed this is evolving, it’s important to step back and focus on what matters most for investors. This includes:
1. Software performance is fine (for now). Earnings have actually held up well in the aggregate, but concerns relate to how these businesses can sustain margins and growth with the threat of cheaper and more efficient AI-alternatives. Some will harness the power of AI to continue to grow and possibly even improve margins. Some will not. The issue for credit investors is that software borrowers will need to spend more to build up their AI capability, potentially accelerating their demise if they cannot make the transition.
2. Capital structures are the problem. Valuation multiples have declined sharply. Many US private credit firms have emphasised how they have lent to software businesses at low loan to value (LTV) ratios of 30 – 40 percent leaving significant buffers against valuation declines. However, with valuations declining by 40 percent, or more, LTV buffers have been meaningfully eroded, even where earnings growth is factored in. Adding to this is the need for capex spending to continue and even accelerate as AI implementation intensifies. In syndicated loan markets, where prices are observable, prices on loans to software borrowers are down by over 5 percent in 2026 alone. Listed software focussed Business Development Company (BDC) equity is down 20 percent year to date and trading at a >30 percent discount to net tangible assets.
3. Fund flows matter. Due to the scrutiny on the sector, many interval funds were already hitting their redemption gates in Q4 25, and this has only worsened in Q1 26. Goldman Sachs reported redemption rates of 5 percent on average in Q4 with one technology focussed BDC at 15.4 percent. The sector went from US$10bn in net flows in Q3 25 to less than US$4bn in Q4 25. Lack of capital makes it more difficult to extend and pretend as new money will expect to be paid for the higher risk. We are already seeing asset sales (including some to related parties and others at meaningful discounts to par) to pay down debt and return capital to investors. Activist investors have also started tendering for shares in listed and unlisted funds at material discounts to net asset values which will further tighten conditions.
4. Leverage only exacerbates the issue. In mid-2025, the Reserve Bank of Australia estimated global banks had US$300 billion in loans to private credit managers. The size of the US BDC credit market has grown to US$80 billion, from US$30 billion c. 2.5 years, a >40 percent CAGR. Over the past 12 months, spreads have widened by around 0.60 percent at a time when wider market spreads have been flat with trading margins on unsecured bonds for some software exposed BDCs trading well north of 3 percent p.a. With senior unsecured bonds having minimal covenant protection and weak change of control language, the risk of “priming” (i.e. issuing senior secured debt which ranks above unsecured) or other equity friendly activity is a growing concern.
5. This is not just a software story. Within private credit, industry classifications can be subjective. Is a payment platform a financial services business or a software business? Some estimates put the share of private equity investments into software at 30 – 40 percent and Bloomberg have reported on wide variances between how different managers classify borrower industries. Furthermore, the reality is that software is not the only sector that is exposed to AI-related disruption. Healthcare, e-commerce, business services, and logistics are just some of the industries exposed to AI related disruption.
Now turning to the domestic private credit market, there are three important factors for investors to consider:
1. Exposure to software/AI redundancy risks are relatively lower. We put software exposure in Australian private credit at less than 10 percent, less than half the exposure within US private credit markets. With private credit’s penetration into the Australian market at much lower levels than in the United States, we have also not seen the same levels of aggressive structuring in the deals. Annual recurring revenue loans, which are loans to high growth SaaS businesses secured by revenues rather than profits, are not a feature of the Australian market.
2. Investors still need to dig. There are Australian managers who have meaningful exposure to US private credit via joint ventures as well as funds who have directly invested in Collateralised Loan Obligations (CLOs) or debt to BDCs. There is even a business development company with high exposure to software, which has issued an Australian dollar denominated unsecured bond into the domestic public markets. It’s not as simple as putting a line through all Australian managers and saying they are fine. We have been somewhat surprised at the lack of response in Australia.
3. Fund flows matter here too. To date, the domestic market has outperformed offshore with private credit Listed Investment Trusts (LITs), even those exposed to US private credit, trading at much lower discounts to net assets than listed BDCs. However, retail flows into private credit funds have slowed as investor concerns around governance practices and fears of losses in commercial real estate development loans have persisted. Lack of flows will result in tighter liquidity and tighter financial conditions, which in turn will lead to higher defaults.
The challenge for investors in this environment is that the assessment of the risk of a fund investment is not just about the underlying assets of the fund. It’s not just about the manager, their skill, or their governance practices. A major determinant of outcomes will be how other investors respond, which is a much tougher risk for investors to assess.
The risk of adverse outcomes can be mitigated by partnering with managers who have size and scale as well as access to capital. A private credit firm with a single open-ended fund, poor valuation discipline, already elevated external leverage, and lack of scale is far more exposed than one with multiple sources of capital, a genuine fair value process, scale and flexibility.
Transparency and a conservative approach to governance risks are critical in uncertain environments where investors are disposed towards redeeming first and asking questions later.
