Private equity: The Red Thread – Alternatives

Private equity returns had a strong quarter, with steady fundamental performance during a turbulent 1H26 that contained several surprises. Artificial intelligence (AI) fears weighed on software valuations in private equity (PE) portfolios, as funds scrambled to assess the threat of AI to business models. Public software valuations continue to face pressure in AI‑exposed segments, although the market is becoming more perceptive to business model differences. This repricing in public markets increases the risk of delayed spillover effects on private software valuations.

Investor concern is driven by fears that software companies may be less valuable in the AI era, with lower long-term profits and unclear terminal value. There is currently little indication that fundamental performance has been impacted to date, i.e. the sell-off is based on a downside case for the future of the software business model.

Privately held software companies in most instances have not been impacted by lower reported revenue or demand. We believe that companies providing control-of-access, systems of record, governing critical workflows, and operating in environments where breaches or failures would be costly are best insulated from AI’s encroachment on software business models.

Some companies in these categories may indeed benefit from AI, as efficiency improves and lower cost of delivery has the potential to boost margins. Incumbents have a natural opportunity to benefit from those trends, as long as product differentiation can be maintained and AI can be incorporated into these platforms swiftly and without defect. We have seen tangible examples of AI adoption leading to margin expansion, greater revenue per user, and faster growth within privately held software companies.

The Middle East conflict is also leading PE portfolios to position for further uncertainty into midyear, but few impacts have been materially felt as of yet. Especially in the middle market and lower middle market, PE revenue exposure skews domestic, while second order effects, in the form of higher inflation driven by increased energy prices, have yet to be fully captured.

These effects have certainly permeated on a sector-by-sector basis (e.g. transportation costs), but are not yet dominating the operating environment the way inflationary pressures did in the years immediately following the pandemic. For now, the size of the effect on private companies appears modest, with the duration remaining unknown amid the broader conflict.

Figure 1: Private equity quarterly fund returns (%)

Source: PitchBook, April 2026. (* denotes preliminary data). Past performance is not a guarantee for future results.

Private equity has taken these in stride for the time being, though we do expect a softer exit environment for software and adjacent technology companies owing to the increased uncertainty.

Overall, the exit environment has fallen short of private equity funds’ expectations, in part because of persistently high interest rates. Most investors continue to expect a pickup in activity if rates eventually trend lower.

Venture capital (VC) continues to set records with AI investment, which is far eclipsing any other sector and is approaching 50% of all VC market value in 1Q26. Still in its early innings, AI adoption is increasing at a tremendous pace, and valuations have been a rocket ship for investors: comparable round valuations for AI companies are nearly double those of others. Markets remain euphoric on recent funding rounds, in some cases exceeding 2021’s highs.So far, VC remains undeterred in the face of some macro headwinds, although quarterly performance was flat to down in 4Q25. Further to our earlier comment on exit activity, IPOs of VC-backed companies remain well below trend and have not exceeded 50 in a year since 2021.

Higher energy prices will likely weigh on VC-backed AI companies, whose substantial compute requirements demand enormous amounts of energy.

Many of today’s AI business models are acquiring users through subsidized compute, much in the way that now-established platform businesses gave away free rideshares and meal delivery before ratcheting up unit economics. A sustained rise in energy prices risks raising uncomfortable questions for today’s AI business models.

Figure 2: Venture capital quarterly fund returns (%)

Source: PitchBook, April 2026. (* denotes preliminary data). Past performance is not a guarantee for future results.

Private equity sector performance outlook