[00:00] Brad
 Welcome to another episode of The Flip Side. It's Brad Rogoff, Global Head of Research. We have a very topical episode for you today. At least in my opinion. And of course, don't forget to hit subscribe so you can listen every month. Joining me for this episode is Ben Bullish. Ben is our Equity Research Analyst covering the US brokers, asset managers and exchanges.

[00:21] Ben
 Good to be with you here, Brad.

[00:23] Brad
 All right Ben. So, the reason I invited you here. A big chunk of your coverage universe. You know, they're asset managers. And while that may have started as a traditional asset managers kind of mix of that and private equity firms, the landscape it's changed a ton right. So, a large part of the universe today, it's actually what we call alternative asset managers.

 And that's been a good thing for a while to be clear. So, you know, whether organically or through M&A these firms have grown. It's private credit. That's been the main mechanism for them to grow recently. So, while that has been a positive, it's feeling a bit less so right now.

[00:55] Ben
 Yeah that has definitely been the growth channel over the last several years.

 And it feels like it's hard to argue that asset accumulation won't slow in the near term. But we do think it's a bit of a leap to go from, you know, not a good thing to the stocks being down, you know, 25% plus.

[01:08] Brad
 It's a big move. Definitely. And look I'm not taking that move lightly, especially when we think about the software sector which is really behind a lot of this price move in the asset managers and that's also down.

 Let's call it about 25%. It's kind of an eerie symmetry there. But to me I actually think it's sensible. And that's because it's not just about growth. It's also about what you own. And we should debate the equity valuation angle a bit. I promise we'll get there. But just what is priced into these alternative asset managers at these lower multiples?

 So first though I think we need to address the elephant in the room. And that's what the assets are that they own today. So let me ask you in your conversations when you're talking to people what you're doing all day right. What do they bring up when they're talking about concerns about private markets or private credit? Obviously loop AI into that probably right now. What are they actually worried about?

[01:54] Ben
 Yeah. The first thing they're worried about is that a lot of this market is invested in software, software, another, you know, tech enabled business models and that faster AI adoption could pressure revenues and cash flows, ultimately create, you know, some terminal value risk for portfolio companies.

[02:08] Brad
 All right. So the catalyst for all of this was it was a few weeks ago really.

 Right. We had the release of a handful of new plug ins from Anthropic sent shockwaves through the market hit software companies and then the alternative asset managers really quite hard. So a big part of the worry for these asset managers, it's concentrated in what are called business development companies. Well, we'll use the term BDCs here. And many of them have been really the channel of asset growth.

 You know, not just private markets, but really BDCs within that for the asset managers you cover. So considering the huge software exposure in BDCs, it makes sense to me that they're getting more attention than other parts of private markets.

[02:47] Ben
 You know, again, I understand they're getting more attention, but this is a lot of attention. In addition to the equity of all the alternative asset managers seems to have been indiscriminately sold, regardless of the extent of their BDC exposure.

 BDCs are the most direct retail facing vehicles for private credit. They've grown very rapidly over the last several years as rates rose and other rate sensitive asset classes like real estate lagged. And, you know, importantly for the managers more broadly, they do generate very healthy fee related revenues. And so, you know, the retail investors are generally quicker to sell, which has made the BDCs the focal point of the sell off.

[03:17] Brad
 So headlines leading to retail selling, I mean, that happens all the time. It happens across asset classes and sometimes it's justified, sometimes it's not. So if investor though is negative on software, the exposure is real. I mean we're talking about 20% of the average BDC collateral. You know, the loans that they have, that are software related. And these are also levered vehicles.

 The BDC is that is which helps justify a little bit more extreme price moves to me.

[03:43] Ben
 Yeah. You know, the number is big. And I'm somewhat sympathetic to the narrative that concentration and crowding from many of these vehicles with similar investments can exacerbate the problem. But, you know, as my colleague Raimo Lenschow highlighted on the recent Barclays brief, this is not 20% of the portfolio that's likely to go away.

 There's plenty of software companies that provide mission critical services, and despite AI options, the firms are unlikely to shift away from their existing providers, who will probably be using AI to enhance their products.

[04:05] Brad
 As anyone who listens to this podcast knows, I'm a critic at heart, which tends to make me more pessimistic. But I do hear you.

 The doomsday scenario. It is a bit farfetched. Still, what you had here is a sector. That asset managers had poured into, because they expected growth. And with that growth, they expected these companies to quickly de-lever. And many of the companies really had started in mass debt, often through leveraged buyouts, to the tune of 5 to 7 times their EBITDA.

 And before we even talk about the downside, there's a problem that these companies just they may never grow into those capital structures.

[04:39] Ben
 That's fair, but I actually think you need some of the draconian scenarios to be true before I worry about the BDCs and subsequently, you know, the companies I cover, the performance of the books to date has been pretty strong.

 Defaults and nonaccruals are low and haven't seen any meaningful change. You know loan-to-value ratios and software loans tend to be closer to 30%. So they have a bit more equity buffer than the average loan which is closer to 40%, as a lot of the managers like to say, if the credit has a problem, the equity has been long wiped out.

[05:04] Brad
 All right. I can't argue with your numbers of starting points, but what if we move a bit to the finish here? And what you said with regards to the equity potentially being wiped out. So loan-to-value was often based on a value when these deals were first done, that was what a private equity company was willing to pay when they thought software was a pretty high growth industry.

 And by the way, the companies you covered that have private equity arms, that actually own that equity. So now I have two reasons that all managers should be, you know, down as much as software companies, I think.

[05:39] Ben
 Yeah. So look, on our end we are making adjustments to the private equity sides of the businesses and our models. But again, I would reiterate, the selloff is indiscriminate with respect to whether the firms are heavy in private equity or not.

 And even when you're talking about BDCs, there is some precedent. You know, this happens in the non-traded REIT sector. A few years ago, everyone said the sky was falling, but from peak to trough we saw net asset values decline maybe 20%. You know, it wasn't a particularly heroic story, but they certainly didn't go to zero.

[06:03] Brad
 But it's kind of been persisting for a little bit here now.

 When we think about BDCs private credit. Right? You think about the private credit negative headlines in the fall with BDC selling off 10 to 20% of net asset value, or NAV, despite no corresponding real change in fundamentals. And the non-traded BDCs, they also saw redemptions. They're at their highest level in several years. If we look at Q4 of 2025

[06:25] Ben
 That’s true. But Brad, you know what happened last fall wasn't really a private credit thing. It was a few idiosyncratic cases of corporate fraud involve loans that were held by larger asset managers, syndicated by banks and, to small extent, private credit. And, you know, more broadly, I would separate retail facing BDCs from private credit in general. You know, the outflows we're seeing have been limited to the wealth channel.

 But the institutional appetite for private credit doesn't seem to be showing any slowdown at all. And even in wealth, this doesn't seem to be spilling into other asset classes.

[06:49] Brad
 Okay. So if that's fair, then let's pivot to, you know, really the rest of the private market space, not just this BDC stuff. Right. But that gets the sell off in the managers.

 It's been even more severe than actually the BDC. So we said we would come back to equity valuations. I feel like I've justified the sell off through several channels, but you still seem to think the math doesn't support this level up the clients.

[07:12] Ben
 Yeah, Brad. But you know, to be clear, I have adjusted my forecast lower since we just can't dismiss this BDC point we've been debating here.

 The BDCs are important for equity valuations. We've talked about the growth has been really robust. But it's not just AUM. You know these are really lucrative products for the managers. BDCs especially wealth BDCs deliver higher than average fee rates and are bringing in quarterly performance fees across the group. The private BDCs alone range from five to as high as 20% of last year's fee revenues, and that's where growth is now in question.

 Now, why is that important? It has to do with how the stocks are valued. Investors tend to place a lot more value on fee-related earnings. You know, unlike the irregular performance fees, the earnings are a lot more predictable and growthy. Investors usually apply multiples in the 20 to 30 times range to that revenue stream, versus maybe 8 to 10 times for other types of fees.

[07:54] Brad
 All right. So, the math is helpful. Certainly understand why you care so much about growing things like fee related income. And even though investors don't place as high value on the earnings stream from private equity realizations, you gotta admit the whole industry is struggling from a lack of capital return over really the last 3 to 4 years, I would say.

 So at some point. I think the flywheel does matter. If you're a manager, you got to raise money, deploy it. You want to realize you know those gains and then return it. And the environment. It's already been challenging and now we've got this new AI disruption narrative. I think it just makes it worse across these entire firms.

[08:30] Ben
 Yes and no. You know, there are some tech specific PE firms that kind of orient in that direction. But for the big public companies, I look at, you know, the company wide allocation to software across private equity are generally less than they are the BDCs. It's just not as high. You know, the highest software exposures across our coverage are around, you know, 10 to 11% firm wide.

 And maybe for the you know, kind of tech-oriented managers, 20%. But of the private equity book, you know, in private equity is also another offsetting dynamic in a credit fund. You either get repaid or you don't. In the PE business, though, you can have great performance in some investments that offsets challenges in others, and that dispersion is really important to overall returns.

 And from what we've seen so far, the appetite is there for private equity. It's not like it was in 2021. And it's not the same uniformly across all managers. But for the largest, most scales and successful GPs, you know, we're generally seeing successful fundraises for flagship funds.

[09:20] Brad
 But at what point does it become a problem for the industry?

 Because the behavior, the stock seems to be suggesting something's going wrong beyond just tough realizations and a slowdown in BDC fundraising seems to imply, at least to me, there's something more challenging here than just having a few portfolio companies with a problem.

[09:35] Ben
 Yeah, it's a few things going on here. So we talked before about how the stocks are valued.

 Investors rely on a sum of the parts. They apply different multiples to the different fee streams. It's complicated. Part of the challenge here is it's hard to come to a consensus around valuation. It's just hard to look at a historical PE multiple and say mmm... a certain stock is now undervalued based on where it's been in the past. Keep in mind too, these stocks are pro cyclical.

 They perform great when the market backdrops really healthy. Feels like right now we're kind of going through the opposite. But this valuation nuance in the space just makes it harder to call a floor and say the stocks are too cheap to find.

[10:05] Brad
 Even if we're not talking about an existential problem. In the software portfolios, how else do these companies grow?

 If the stocks are to bounce back? There has to be a channel for growth. A lot of the alts have seen meaningful growth in the insurance channel. Actually, there's another option, I guess, in recent years, but that's once again, private credit play is the additional yield. And private credit has supported higher rates for annuity policies.

[10:27] Ben
 That's a fair point.

 You know, insurance has become a huge business for these companies. The largest in my coverage are managing hundreds of billions of insurance AUM. But keep in mind, you're the overexposure that we're talking about in the BDC channel tends to exist in the unrated or sub investment grade part of the market. Insurers are still very heavily weighted towards treasuries, investment grade corporate debt and other asset backed credit.

 So it's harder to get a clear answer due to the differences in reporting. But our assumptions would be insurers tend to have much lower allocation to software than the BDCs and with much stricter investor protections, you know, seniority in the capital stack and things like that.

[10:57] Brad
 I agree it's less software and less concerning with those ratings that you mentioned.

 But as you say, also, it's more opaque than BDC's where we can actually get information since many of them are public. Feels to me like you've got a sector. It's going to stay interesting here for a while, right? Even if we don't think the draconian scenarios play out, there's certainly an interesting equity valuation as we've debated here.

 And look, you know, they're always wanted to being differentiation after any indiscriminate sell off. So thank you for joining me and debating this wide range of topics today, Ben.

 For investment bank clients who want to go deeper on this topic, you can find more detail in our latest research that includes “Barclays High Yield Software Agentic AI Disruption Risk and Focus”, “Software Is Not Dead, Just Changing” and “Widespread Exposure to Software Creates Uncertainty”. Don't forget to subscribe so you never miss an episode.

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