From "Software Doomsday Theory" to the Shadow of Bad Debts, Private Credit and BDCs are Facing a "Contagion" Panic Sell-off

This week began with a global stock market plunge driven by the technology sector, quickly engulfing large-scale investments and private credit financial companies that have been lending to software manufacturers believed to face AI development risks. Alternative asset managers, investment banks, and Business Development Companies (BDCs) are all under severe pressure—after the launch of Anthropic’s latest AI tool sparked panic, investors are fleeing software stocks, worried that giants like Oracle, Datadog Inc., and FactSet Research Systems Inc. are in danger. The core market concern is that these financial institutions could suffer significant losses due to potential massive bad debts associated with these software creators.

“Sell-offs in software stocks have triggered declines in the financial companies holding them, especially those with leverage,” said Mark Hackett, Chief Market Strategist at Nationwide. “The intensity of this sell-off is further amplified by overly crowded trading and the exit of bullish forces.”

Software stocks plummet, and the stocks of BDCs and private credit financial companies fall accordingly

The Nasdaq 100 Index, which is technology-heavy, is expected to record its worst weekly performance since early April, when broad tariffs introduced by President Donald Trump caused chaos in global markets. This shock has also spread to other sectors, with some areas in the financial sector suffering heavy losses. An asset management indicator fell more than 6% this week, and the Invesco Global Listed Private Equity ETF dropped over 7%, both likely to mark their worst weekly performance since April. Meanwhile, the VanEck BDC Income ETF declined 5.6% this week, its largest weekly drop since October.

As shown in the chart above, private credit stocks follow the downward trend of the software sector, with asset managers declining due to investor concerns over potential losses from bad debts related to the software industry.

“Timing the market is very difficult, and emotion-driven sell-offs are rarely wise,” Hackett said. “But I would encourage investors to review their exposures to ensure they align with their long-term plans.”

From a credit research perspective, this is more likely a pre-emptive pricing driven by “emotional spillover + rising discount rates,” rather than a systemic wave of bad debts confirmed by financial statements: several institutions emphasized during earnings calls that their tech/software loan portfolios remain “high quality/clean,” and Bloomberg Intelligence noted that the impact of AI on software borrowers is difficult to observe immediately in credit data and requires time to become apparent. Short-term key indicators to watch include: software borrower ARR growth and net retention changes, discount/promotion levels, deterioration in customer concentration, non-accrual loans rising, redemption pressures on funds, and frequency of valuation downgrades.

On the macro liquidity front, the latest LSEG Lipper fund flow data shows a decline in risk appetite—net outflows from the tech sector, with funds shifting into value-oriented, undervalued industrial stocks and metals/mining stocks, while bonds and money market funds attract capital. This indicates a market actively reallocating by reducing holdings in tech and high-beta/momentum strategies and gradually increasing defensive/cash flow assets visibility.

In recent years, many BDCs and private credit funds have had software among their top ten industry exposures; when software stocks decline rapidly, the market immediately worries about two things—(1) credit lag risk: customer churn, price reductions, and renewal declines eroding EBITDA and cash flow first, then affecting debt coverage and defaults; (2) narrowing financing and exit windows: rising refinancing costs and slowing M&A/IPOs reduce the recovery efficiency of private credit “exit to retreat.” As a result, investors often sell leveraged managers/BDCs with strong software loan portfolios (such as those related to Blue Owl) and quickly externalize risk through ETFs and secondary market pricing.

Blue Owl Capital Inc., an alternative asset manager initially focused on providing significant financing support to software companies, is now experiencing the most severe sell-off in the financial sector. The stock has fallen for 11 consecutive trading days, the longest decline since its IPO in 2021, with a total drop of 26%, reaching its lowest level since August 2023.

Shares of BDCs focused on private credit loans, including those under Blue Owl, have also fallen to multi-year lows. Blue Owl’s technology-focused BDC is currently trading at its lowest level ever.

“Software is often one of the main industry exposures for BDCs,” said Ebrahim Poonawala, Senior Analyst at Bank of America, in a report on February 4.

This week, investors are on edge, waiting for executives from Blue Owl, KKR & Co., and Ares Management Corp. to provide optimistic signals during their earnings calls with analysts, trying to ease concerns about their book of software exposure.

“Technology-focused software portfolios remain among the highest quality and cleanest in all our investments,” said Marc Lipschultz, Co-Founder of Blue Owl, during Thursday’s earnings call.

However, the severe issues investors anticipate are unlikely to immediately manifest in earnings and portfolios.

“The challenge is that the impact of AI on software borrowers is unlikely to be immediately clear in credit assets and will take time to emerge,” said Michael Kaye, Senior Analyst at Bloomberg Intelligence.

The panic over software sell-offs is adding to the pain in a sector already uneasy due to private credit threats last year. Last week, after Blue Owl’s software and tech-focused BDC significantly increased investor redemption limits, investors withdrew about 15.4% of its net assets. Meanwhile, BlackRock TCP Capital Corp., a private debt fund under the world’s largest asset manager BlackRock Inc., saw its stock decline nearly six years’ worth of losses after writing down a series of problematic investments.

“Is the ‘software stocks doomsday’ talk just exaggerated panic?”

However, some professional investors believe that the sharp decline in stocks related to private credit markets has been exaggerated, especially since it’s still too early to assess the full impact. Senior executives in the software and chip industries generally say that the narrative of an “end of software stocks” driven by AI agent waves is an overblown panic.

“If this truly marks a turning point for BDCs, we should see widespread deterioration in earnings and accelerating credit pressures,” said John Cole Scott, President of CEF Advisers. He has increased his holdings in BDCs during the sell-off, including some stocks in Blue Owl’s tech funds. “The recent price weakness seems more like emotion spillover rather than broad balance sheet damage.”

Michael Cyprys, a senior analyst at Morgan Stanley, wrote in a report on Wednesday that AI disruption in the software industry could also create new ultimate winners, and a highly diversified portfolio might benefit significantly if these winners offset poor investments elsewhere.

Matt Maley, Chief Market Strategist at Miller Tabak & Co., believes BDCs should be poised for a rebound, with the key question being when.

Poonawala noted that concerns about AI disruption could also threaten large commercial banks by eroding M&A and IPO activity. Since Tuesday, Goldman Sachs’ stock has fallen nearly 6%, and Morgan Stanley’s has dropped 5%, both marking their worst three-day performance since November.

Poonawala said that the profitability of boutique investment banks is a good indicator of whether capital market activity is being disrupted. For example, Evercore Inc. has not seen its business affected in the short to medium term, according to CEO John Weinberg during Wednesday’s earnings call. However, if market conditions remain turbulent for a long time, it will be hard to deny the impact. “If the market becomes very chaotic and we say it won’t affect our business, that’s unrealistic,” Weinberg said. “It certainly could.”