Beyond the Roar

For nearly seven centuries, the Roman arena stood at the center of public life. It was not merely a venue for combat but became an economy of perception. Gladiators were classified, trained, and matched according to a system far more deliberate than the spectacle suggested. Some were heavily armored, built for endurance. Others were agile and lightly equipped, designed to dazzle but often structurally exposed. The crowd rarely understood the distinction – a reminder of how powerful perception versus reality can be. What earned applause was typically what appeared dominant in the moment, but not always what was engineered to last. Contrary to popular belief (and Russell Crowe’s best efforts), most bouts were carefully managed. The system was designed to preserve its most valuable assets, and it was done with intention. The principle of designing for durability rather than spectacle is not unique to ancient Rome. As we highlighted in our 2026 outlook, CTRL + ALT + CREDIT, we argued that outcomes in the credit markets this year will be designed, not discovered, and that the market would increasingly reward selectivity over reach. Our thesis has not changed. Today’s credit markets carry more than a passing resemblance to the dynamic of the Roman arena in our view.

A lot of capital, much of it through the wealth channel, has flowed toward what has been most visible, most accessible, and most immediately rewarding, particularly direct lending. Strong income, stable performance, and growing investor access have drawn significant flows into areas that appear to deliver both yield and consistency. The crowd, in effect, is cheering. But as in any arena where perception and structure coexist, what wins applause is not always what proves most resilient when conditions shift. Today, there are two dynamics at play that determine a gladiator’s fate in the arena: the fundamentals themselves, and the gap between those fundamentals and investors’ perception of them. As we reflect on the first quarter of 2026, the distinction between spectacle and substance has become harder to ignore, and increasingly important to understand. That is not to say this tension is new. We would argue it has been building for some time. But for many, Q1 was the quarter it became impossible to ignore.

At the start of the year, we emphasized portfolio construction would be a defining differentiator and that the margin for error was narrowing. If anything, the first 90 days of the year reinforced that conviction with more urgency. The macro backdrop has grown more complicated, not less. Geopolitical tensions, most notably the evolving conflict involving Iran, have moved from tail risk to central market driver, roiling energy prices and reshaping inflation expectations in real time. The fervor around AI’s anticipated disruption continues to reverberate across an increasingly wide range of sectors, compressing equity valuations for businesses once considered structurally durable and often focusing more concern about the credit underpinning them. And the narrative around private credit, which had been building beneath the surface for over a year, broke into the open in a way that demanded attention from everyone.

Against that backdrop, it is worth stepping back to acknowledge something fundamental. The extension of credit is one of the oldest practices in civilization. The infrastructure has changed, the instruments have multiplied, and the participants have diversified, but the core function has endured: connecting capital with opportunity, and pricing risk along the way. In 1989, the leveraged finance market was predominantly high yield bonds and totaled approximately $189 billion. Today, U.S. high yield alone stands at roughly $1.5 trillion, a figure that has been largely flat for several years. We think that stasis is worth watching. High yield has had its moments before, and we suspect another one may be building as evident by U.S. high-yield issuance reaching a 7-month high in April (including the heaviest net volumes since April 2020). More importantly, the total addressable global credit market now spans more than $45 trillion across corporate, asset-based, and structured credit. That growth has been fueled by innovation, the globalization of capital flows, structural demand for diversified income, broadened access, and the institutionalization of origination. Every chapter of that evolution, from the acceptance of noninvestment grade debt in the 1970s, to the popularization of leveraged buyouts (LBOs) in the 1980s, to the expansion of direct lending in the 2010s, has followed a familiar arc: innovation opens the door, capital comes in, and the market eventually tests who built for permanence and who built to navigate hard moments.

The last five years alone have produced a remarkable expansion in diversified income solutions, from asset-based finance to hybrid capital structures to new vehicles designed to bring credit to a broader investor base. The architecture of credit has been quietly but deliberately built. That is the context in which the current moment should be read, because we are in one of those defining moments now. The question is not whether credit as an asset class is sound. It is. The question is which corners of the market were built to withstand the volatility that arrives when conditions change, and which were assembled during a period when confidence outpaced caution. History does not punish optimism. It punishes the absence of preparation and discipline. Both conditions can exist in the same market and that is the lens through which we are approaching this note.

With this framework in mind, we address the following themes that shaped our perspective this quarter:

The Arena
A review of Q1 credit markets, where dispersion has become bifurcation between quality and risk, and the same yield proved, once again, not to mean same risk.

Playing to the Crowd
A deeper look at the forces reshaping the private credit landscape, from software debt and AI disruption to retail flows and the questions investors should be asking.

Applause versus Outcomes
How we are positioning for what comes next, with an emphasis on credit selection, portfolio construction, and why a revived M&A cycle and the structural advantages of the bond market may catalyze a renaissance in high yield in the quarters ahead.

The Arena

The first quarter of 2026 tested the resolve of credit markets in ways that felt both sudden and, for those paying attention, desired. What had been a relatively constructive start to the year, with disinflation progressing, a pent-up M&A pipeline, and rate easing expectations building, gave way to a more complex and less forgiving environment. In February, Anthropic’s release of Claude Cowork ignited a global selloff in publicly traded software and IT companies, fueling investor fears that AI-driven automation would undermine the subscription-based revenue models that had made software the darling of many markets. Shares of Salesforce, Oracle, Intuit, Adobe, and Workday were among those punished. The narrative quickly extended into credit, where the absence of hard assets in software borrowers’ capital structure combined with the use of leverage in recent vintages, drove an even more pronounced repricing in the debt of highly leveraged software borrowers across both public and private markets. That shock collided with an already shifting macro backdrop: the escalating conflict involving Iran pushed oil prices above $100 a barrel, the disruption to the Strait of Hormuz introduced supply risks extending well beyond energy, and what had previously been a higher-end energy scenario became effectively the base case.

EXHIBIT 1: Global Credit Markets Endured a Tough Q1, But Have Since Snapped Back (Ex-CCC Leveraged Loans)

Year-to-Date and Q1 Returns Across Global Credit Markets

Against that backdrop, both the U.S. and European leveraged loan market slipped into negative territory for Q1, posting -0.55% loss and -1.05%¹ loss respectively. This was the weakest first-quarter reading for the U.S. since the COVID-driven sell off in March 2020 when the leveraged loan index fell 13%. U.S. and European high yield also posted losses for the quarter, returning -0.55% and -1.72%² respectively, with high yield funds experiencing one of the worst monthly outflows in March before recovering modestly in April. Repricings dried up in March making it the first month without a single repricing since June 2023 outside of the Liberation Day disruption. As we pen this note, the global selloff has proven short-lived, but the macro backdrop is shifting again. Global bond markets sold off sharply on May 14-15, with 10-year Treasury yields rising to 4.58% and the 30-year Treasury topping 5.1%, their highest level in a year, and Japan’s 30-year yield touching 4% for the first time since those bonds were issued in 1999³. April CPI came in at 3.8%, above consensus, with energy the primary driver, but the more concerning signal was the reemergence of sticky services inflation with core CPI rising to 2.8%. As Henry McVey and our global macro team have noted, acute energy inflation may moderate but services inflation will be harder to unwind.

All the while Credit markets have snapped back from the Q1 lows, driven in no small part by the same rules-based and technical capital flows we discuss later in this note, even as the rate backdrop grows more complex. Valuations remain largely unchanged despite elevated uncertainty, indicating that little additional risk premium is currently being priced in for quality assets.

Overall, deteriorating investor sentiment was a defining theme of the quarter, and it predated the software selloff, even as that selloff deepened it. But as we have noted in prior letters, markets that appear uniformly stressed on the surface often tell a more nuanced story underneath. You have heard us say before: the same yield does not mean same risk. The same asset class does not mean the same resilience. The same strategy does not mean the same portfolio construction. In a market like this one, that distinction is key to the equation. The crowd saw a quarter of noise and reacted accordingly. But underneath that noise, the market was doing what markets are supposed to do: repricing risk, rewarding quality, and testing who was prepared.

EXHIBIT 2 U.S. Leveraged Loan Market Experience First Negative Quarter due to Software Sell-off

Q1 Historical U.S. Leveraged Loan Total Returns

Nowhere was that sorting more apparent than in software and services sector. The Q1 numbers tell part of the story: the S&P 500 software and services industry group fell -23.4% for the quarter, while the sector for leveraged loans returned -5.7%, and high yield -3.4% as of March 31, 2026⁴. If we zoom in on the leveraged loan market, software and services loans have traded in a relatively narrow range, with average bid prices hovering around 94.5 and rarely diverging more than two to three points from the broader leveraged loan market since 2022. By the end of Q1 2026, that picture had changed materially. Software loan bids fell to 87.97, the lowest reading in the four years, while the rest of the leveraged loan market held within roughly a point of where it began the year. The gap between software and non-software loan bids widened from under two points historically to more than eight by quarter-end, more than three times any spread observed since 2022.

What the historical return data shows is that software and services loans had already been quietly underperforming the broader LSTA Leveraged Loan Index since mid 2022 – well before Q1 made it impossible to ignore. The underperformance was not dramatic in any single month. It averaged 20-50 basis points and accumulated steadily, rarely drawing too much attention. The sector looked like it was keeping pace, but the underlying data told a different story.

The contrast with high yield was equally telling. Software bonds held materially better than their loan counterparts, a reflection of the high yield market’s lower software concentration and structurally higher credit quality, the same attributes that we believe position it well for what comes next. The headline number captured the pain. The underlying data revealed where the pain actually lived. This was not a market in broad retreat but rather a market sorting itself, sector by sector, credit by credit, in real time.

EXHIBIT 3 Dispersion in Soware & Services loans has been in effect since Q3 2022

Weighted Average Bid Price of U.S.