AI Anxiety May Be Overblown, but the Disruption Is Real, Says CION’s Mark Gatto

CION’s co-CEO discusses how AI is influencing software valuations and why it’s always all about diversification.

Artificial intelligence is slated to create a wave of new innovation this year, and that’s causing more than a fair share of anxiety for investors.

McKinsey estimates that AI will create $340 billion in value in the banking industry in the coming year, and in wealth management, firms are anticipating productivity gains of more than 30% annually. For clients, that means weighing both the risks and opportunities the technology presents across public and private markets. It’s also sparking new questions about the durability of software business models and the broader implications for private credit and infrastructure investing. 

Mark Gatto, co-CEO of CION Investments, said the current market reaction may be overblown, but the disruption is real. In this conversation, Gatto discusses how AI is influencing software valuations, where he sees opportunities emerging, and why it’s always all about diversification.

Advisor Upside: AI has been a huge driver of growth. But it has really impacted the markets in recent weeks and some of that is spilling over into those private investments as well. Where is all this AI disruption happening right now?

Software in general has been a very prominent asset class with a lot of funds and investment professionals seem to be attracted to it because of its characteristics. Software companies have high cash flows, low capital, [low] asset intensive, where you’re not pouring a lot of money into it. So it’s been an area where a lot of money has flowed, and now we’re seeing AI giving people pause and a scare, if you will, because the belief is that some of the technology that AI brings to the table could disrupt or displace the software companies.

So there’s been concern — rightfully so. At this stage, it’s a little overblown and there’s an overreaction. But that’s not unusual when there is a disruptive technology, right? There’s always something that comes out that people have concerns about. But, it takes time to really understand what the true long term impact will be. 

I’m using AI myself and doing things that I wasn’t able to necessarily do before, and do it very efficiently. So there is going to be that concern. But I look at AI as more of an opportunity. There’s going to be an opportunity for companies to be more productive, even for software companies. There’s going to be a use case where they can leverage AI to improve their products. Now, will there be some losers in this equation? Of course, there always is. But from an investment perspective, it’s about managing those risks, understanding your portfolio companies, and hopefully you did a really good job of underwriting these names when you invested in the businesses. Hopefully, they’re supported by good private equity firms and they’re well capitalized to either withstand a storm, so to speak, or more importantly, adjust. That’s really the name of the game here: how are these firms going to react given where AI is today?

Every time I use ChatGPT, I’m finding new use cases for myself. So I understand the investor trepidation in some of those names. But, you mentioned winners and losers, how do you go about finding those compelling investments?

We have to really look at what these companies are doing, what area of tech they are in, what area of software provision they are in, and companies that are providing B2B or some sort of critical data gathering, companies that are foundational to a company. [The] companies that are working within the proprietary areas, they’re going to be less impacted than companies that are creating content, or just managing information, generally speaking.

So you really have to dig a little bit deeper. I don’t think you can throw the baby out with the bathwater here. You have to really see what these companies are doing. Are they displacing? It’s something we talk about in underwriting. Even before that, we want to understand: can this company survive or can they be displaced? Are they a critical service to a corporation? And if you can get your arms around those things, you can feel fairly comfortable. If we look at the software companies in our portfolio, they are actually performing very well. The loan to value equation is very favorable, sort of mid 35 ish percent loan to value right. Firms that are well capitalized that have big private equity sponsors. So if you look at it from that perspective, from an underwriting perspective, and as a credit investor, that’s very important to us. There has to be a lot of deterioration for there to be significant trouble.So we can sort of get comfortable with that situation if we did a good job underwriting.

With respect to portfolio companies, it’s about being proactive. Yes, it’s about being defensive and really understanding where the pressure points are in terms of new business. But, if you are well capitalized and you have cash to put to work, it could be a great time for opportunity. We look at it defensively on one hand, but aggressively and offensively on the other.

There are certainly opportunities and risks in making private asset investments. What advice can you give to managers to try and help mitigate some of those pitfalls?

If you’re invested in a company that has some AI stress points, you’re going to be concerned. You havet to really understand, as I said before, what is the displacement risk for that company? What are the pressure points? What type of industries are they in? Do they have any proprietary angle or are they embedded in a company’s foundational operations? If they are, you can feel fairly comfortable. But it’s not just about that. It’s also about what companies are you going to support if there is some sort of slowdown? You’re going to support companies that have great management teams that can be innovative, that don’t appear to be on a pathway to be completely displaced.

You have to be smart about that too. There’s going to be opportunities to support companies. I liken it to Covid-19. When Covid happened, everybody thought the world was going to end and every company was going to go out of business, and that wasn’t the case. Management teams, they hunkered down. They got smarter about their businesses. They got more efficient. They looked at their costs better, and they innovated. They pivoted and innovated and changed their business plans, and they came out on the other side. That’s what you’re going to see for a large part of this AI disruption. You’re going to see companies pivot, you’re going to see them innovate, you’re going to see them leverage AI. Hopefully, I’m right, and we’re going to see a positive outcome longer term.

Private credit has been making a lot of headlines recently, sometimes good, sometimes negative. But what impact is AI really having on investors? 

Private credit is not going away. It’s a bona fide asset class; it’s an enormous asset class; and, the good managers will have success in this market, will again present opportunities for those that are well capitalized and can access the marketplace thoughtfully.

What’s also making headlines is infrastructure on the positive side. We’re not seeing negative headlines there, and thankfully [because] we have an infrastructure fund, so I’m happy about that. But AI played an impact in that business, too, because it’s created these additional categories of infrastructure. Historically, people think about infrastructure as bridges and toll roads, where now it also includes data centers. And we’ll call it infrastructure adjacency, where [companies] are leveraging technology to create an asset class within an asset class. Like any investment strategy, being diversified can be one of the best ways to play it.