Software selloff raises stakes for active managers

Key takeaways

• Managers generally view the recent selloff as a broad repricing that masks meaningful differences across companies.
• Managers have selectively re-underwritten software holdings, exiting names with elevated disruption risks, while retaining structurally advantaged platforms with defensible moats. Most portfolios remain modestly underweight software.
• Conviction centers on mission-critical, high-switching-cost platforms with the ability to evolve within a changing AI-driven economic model.
• Dispersion across business models increases the importance of active stock selection.

Software stocks experienced one of their steepest relative one-month drawdowns since 2008. The decline compressed valuations across much of the sector in a short period.

In discussions with our active equity managers following the selloff, most described the decline as broad-based, while emphasizing that business moat defensibility and competitive positioning vary significantly across companies.

Several managers described the recent environment as a “SaaS apocalypse,” reflecting the intensity of the sentiment shift. Their analysis centers on whether the selloff has treated structurally advantaged business models as if they carry the same terminal value risk.

In prior cycles, many software names traded with high correlation as duration-sensitive growth assets. Today, portfolio discussions have become more granular. Managers focus on renewal visibility, contractual revenue stability, workflow integration, and pricing leverage as AI capabilities evolve. The result is greater differentiation beneath the surface of the sector.

Managers consistently distinguish between embedded enterprise platforms and vendors whose growth relies more heavily on incremental user expansion.

Mission-critical systems in finance and legal workflows retain high switching costs and low tolerance for operational disruption. Revenue tied to regulatory processes or deeply integrated workflows provides clearer visibility into retention and renewal rates. These characteristics support continued allocation even after multiple compression.

Application vendors tied closely to seat-based growth or discretionary IT budgets receive closer examination. Managers assess how pricing power holds as AI-enabled tools expand functionality and competitive intensity increases. Companies with proprietary data advantages or broader ecosystems tend to command stronger conviction than narrower single-solution providers.

Back-office platforms linked to diversified revenue streams appear more stable across several portfolios. Narrower product offerings exhibit greater variability in expected outcomes. Capital allocation reflects these company-level distinctions.

Positioning changes align with this reassessment. Most managers maintain modest underweight exposure to software. Some have trimmed positions where valuation still embeds aggressive growth assumptions or where competitive uncertainty has increased. Others have rotated within software toward vertical applications, cybersecurity, or infrastructure-oriented models.

Broad sector exits remain limited. Reweighting occurs primarily among individual holdings rather than across the entire category.

Performance impact across diversified portfolios has been contained. U.S. large-cap mandates with heavier software exposure have faced greater short-term pressure, while global and international strategies with lighter positioning have seen more muted effects.

For allocators, this dynamic carries implications. When valuation compression occurs broadly while business fundamentals diverge, return outcomes increasingly reflect the ability to distinguish durable revenue franchises from structurally pressured models.

Managers view the software selloff as a catalyst for deeper differentiation within the sector. The focus has shifted toward deeply integrated, high-switching-cost platforms that can adapt to a changing AI-driven economic landscape, reflecting stronger moat defensibility. As dispersion widens across business models, portfolio outcomes depend more heavily on disciplined fundamental analysis and active stock selection within software allocations.