John Zito, co-president of Apollo Global Management’s formidable asset management division and its head of credit, delivered a stark and unvarnished assessment last month regarding the valuation practices within private equity, particularly concerning their software holdings. Speaking to clients of investment bank UBS, Zito minced no words, stating unequivocally that private equity firms are largely failing to accurately value these assets in the wake of significant declines in comparable public technology companies. His comments, initially reported by the Wall Street Journal and subsequently confirmed by CNBC, have sent ripples through the financial community, highlighting deep-seated concerns within the opaque private markets.
"I literally think all the marks are wrong," Zito told the assembled clients, a statement that underscores a fundamental misalignment between private market perceptions and public market realities. "I think private equity marks are wrong." This direct challenge to prevailing valuation methodologies comes at a time of heightened anxiety across the financial landscape, where the confluence of technological disruption, evolving interest rate environments, and investor sentiment is forcing a reckoning with long-held assumptions.
The Genesis of Concern: Public Market Volatility and AI Disruption
Zito’s critique is rooted in the dramatic shifts observed in the public technology sector. For several weeks leading up to his remarks, investors have aggressively sold off shares of public software companies. This downturn is largely fueled by fears that advanced generative artificial intelligence tools, pioneered by entities like Anthropic and OpenAI, could render significant portions of existing software solutions obsolete. This disruptive potential has triggered a profound re-evaluation of business models, growth prospects, and ultimately, market capitalization for a wide array of tech firms.
The Nasdaq Composite, heavily weighted towards technology stocks, has experienced periods of significant volatility, with key software indices seeing double-digit percentage declines. For instance, the broader S&P 500 Information Technology sector has faced headwinds, with some growth-oriented software companies experiencing declines of 20-30% or more from their recent peaks, eroding billions in market value. This public market repricing creates a stark contrast with private market valuations, which are typically less frequently updated and often rely on historical comparables from more buoyant periods.
The concern is that private equity firms, which acquired numerous software companies during the low-interest-rate era of 2018-2022, have not adequately adjusted their "marks" – the internal valuations of their portfolio companies – to reflect this new reality. These marks are crucial, as they determine the reported net asset value (NAV) of private equity funds, influencing investor returns and management fees.
Private Credit Under Scrutiny: Redemptions and Re-evaluations
The implications of mispriced software holdings extend beyond private equity to the rapidly expanding private credit market. Many of the companies acquired by private equity firms during that boom period were financed not just with equity but also with substantial private credit loans. If the equity valuations are inflated, the underlying health of these indebted companies is also likely weaker, placing the loans themselves at risk.
This linkage has ignited a wave of redemptions from private credit vehicles, as investors, particularly retail investors, seek to withdraw their funds. The Financial Times reported that approximately $10 billion was pulled from private credit funds in the first quarter alone. While this figure represents a fraction of the estimated $1.7 trillion global private credit market, it signifies a notable shift in investor confidence and liquidity demands. Many private credit funds, designed for illiquid assets, often employ redemption gates or other mechanisms to manage withdrawals, but a sustained wave of redemptions can still create significant pressure.
Amid this mounting pressure, some of the most sophisticated players in the financial world are beginning to act. JPMorgan Chase, a titan of Wall Street, has reportedly started to rein in its lending to private credit players and has proactively marked down the value of some of its software loans. This move by a major institutional bank serves as a tangible signal that the market is indeed confronting underlying valuation issues, moving beyond mere speculation. Such markdowns by a prominent lender can trigger a cascade effect, forcing other participants to re-evaluate their own exposures and potentially leading to a broader repricing across the asset class.
A Growing Chorus of Caution
While Zito’s remarks are particularly impactful due to his insider position at a major alternative asset manager, he is not alone in flagging risks within the private credit space. Prominent Wall Street figures such as Jeffrey Gundlach, CEO of DoubleLine Capital, and Mohamed El-Erian, Chief Economic Advisor at Allianz, have long expressed caution about the rapid growth and increasing opacity of private credit. Their warnings have often centered on concerns about declining underwriting standards, rising leverage, the illiquid nature of the assets, and the potential for systemic risk if defaults were to spike.
Gundlach, known for his contrarian views on fixed income, has frequently highlighted the lack of transparency in private credit markets compared to public debt. El-Erian has pointed to the structural liquidity mismatch inherent in funds that offer quarterly redemptions while holding long-term, illiquid loans, warning of potential "runs" on funds if investor confidence falters. Zito’s comments, however, represent a unique and potent acknowledgment from within the core of the private markets industry, lending significant weight to these external concerns.
In response to the growing unease, an array of industry leaders have sought to assuage fears, emphasizing the robust fundamentals of underlying companies, the strong performance of their loan portfolios, and the diversified nature of their funds. These statements often aim to differentiate the current environment from past crises, stressing improved underwriting standards and active portfolio management. However, the actions of firms like JPMorgan and the frankness of Zito’s assessment suggest that such reassurances may not fully capture the evolving risks.
Apollo’s Position: Distinguishing Itself from the Pack
Against this tough backdrop, alternative asset managers, including Apollo, have seen their shares battered this year. Investors are increasingly scrutinizing business models and risk exposures. Zito and other Apollo executives have, therefore, been keen to draw a clear distinction between Apollo’s investment strategy and that of other private credit players, particularly those with heavy concentrations in the software sector.
Apollo’s strategy, as articulated to analysts last month, emphasizes lending to larger, more stable companies, many of which carry investment-grade ratings. Crucially, the firm highlighted that software companies constitute less than 2% of its total assets under management. Furthermore, Apollo explicitly stated it has zero direct exposure to private equity stakes in software firms. This strategic positioning is designed to reassure investors that Apollo is insulated from the most vulnerable segments of the market that Zito himself criticized. By focusing on more established businesses with stronger balance sheets and broader diversification, Apollo aims to mitigate the "bad ending" scenario that Zito warned against for more concentrated and aggressive strategies.
The "Bad Ending" Scenario: Vulnerable Software Holdings
Zito’s comments at the UBS event specifically pinpointed software companies acquired between 2018 and 2022 as particularly exposed. This period was characterized by exceptionally high valuations, driven by robust growth narratives, and a persistently low interest rate environment that made debt financing cheap and plentiful. Many of these acquisitions, Zito suggested, involved "lower quality" companies compared to their larger, publicly traded counterparts, often lacking the scale, market dominance, or diversified revenue streams to withstand significant market shifts or technological disruption.
The core of Zito’s warning for private credit lenders, and by extension their investors, revolves around potential recovery rates. He projected that in a distressed scenario, lenders could recoup "somewhere between 20 and 40 cents" on the dollar for loans to a generic small-to-medium sized software firm, particularly if these companies find themselves "in the wrong place" in the new AI-led technological regime. This potential for deep losses, implying a 60-80% haircut on principal, is a stark forecast that underscores the magnitude of risk. For context, typical recovery rates for senior secured loans in default have historically ranged from 60-80% across broader corporate sectors, making Zito’s 20-40% figure for specific software segments notably pessimistic.
The underlying issue is that many of these software companies, purchased at peak valuations, are now grappling with higher interest rates on their variable-rate debt, increased competition, and the existential threat posed by AI. If their revenues stagnate or decline, and their operating costs rise, their ability to service debt diminishes rapidly, pushing them towards default and subsequent restructuring, where lenders often face significant losses.
Broader Implications and Market Outlook
While Zito’s immediate concerns are focused on specific segments of the private markets, the broader implications are far-reaching. His assessment suggests a necessary recalibration of risk and return expectations within private equity and private credit. For limited partners (LPs) – the institutional investors like pension funds, endowments, and sovereign wealth funds that back these private funds – it implies a potential for lower distributions, longer hold periods, and, in some cases, capital losses. Retail investors, who have increasingly gained access to private credit through various fund structures, face similar risks, often with less understanding of the underlying illiquidity and valuation complexities.
The current upheaval could lead to a more disciplined lending environment, with private credit providers becoming more selective, demanding stronger covenants, and applying more conservative leverage multiples. It might also accelerate the trend towards consolidation, favoring larger, more diversified players like Apollo who possess the analytical capabilities and capital to navigate turbulent waters.
Furthermore, the candid acknowledgment of valuation discrepancies could attract increased scrutiny from financial regulators. Concerns about the opacity of private asset valuations, the potential for systemic risk from interconnected markets, and investor protection, particularly for retail participants, might prompt calls for greater transparency and standardized reporting.
Zito concluded his remarks with a pointed warning: "If you do stupid things and you do concentrated things, and you do things that you’re not supposed to do in your vehicle, you probably will have a bad ending." This serves as a powerful reminder that while the broad asset class of private credit is expected to endure, specific strategies, particularly those characterized by excessive risk-taking, concentration in vulnerable sectors, or a disregard for sound valuation principles, are poised for significant challenges. The coming months will undoubtedly test the resilience of the private markets and force a much-needed re-evaluation of how risk is priced and managed in an increasingly complex financial landscape.
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