Victor Khosla Sees 'Fat' Tail Risk in Credit Markets
Speakers
Summary
- Credit Market Fragility: Khosla identifies a "fat tail risk" in credit markets. Despite high-yield spreads being tight (300 bps), underlying default rates are already elevated at 6% (Moody's data), indicating a disconnect between price and risk.
- The "Software Stick": A major contrarian view is that the Software/SaaS sector represents a looming credit disaster. Many of these companies were bought by Private Equity at 20x+ cash flow multiples. Khosla argues AI will disrupt these "knowledge businesses," causing cash flows to collapse and triggering defaults in the debt backing them.
- Real Assets vs. Knowledge Assets: SVP is pivoting 40% of its portfolio into "Real Assets" (power plants, airplanes, toll roads) and "Real Economy" businesses (e.g., steel), viewing them as insulated from AI disruption compared to "high knowledge growth" sectors.
- Opportunity in Volatility: Khosla views the potential widening of spreads (from 300 bps to potentially much higher) as a massive buying opportunity for distressed/junior capital, targeting 15%+ returns once the correction occurs.
Trade Ideas
Khosla mentions investing in a large European steel company and using AI to "buy better scrap metal," which he claims can create "$50-75 million in EBITDA." This is the "Real Economy" application of AI. Instead of AI *replacing* the product (as it might with software code), AI is used here to optimize logistics and procurement for a physical product. Old-economy industries that successfully integrate AI for efficiency will see significant margin expansion without the existential threat facing the tech sector. LONG. Look for industrial firms with heavy operational costs where AI can drive efficiency. Global economic slowdown or Chinese oversupply could crush steel prices regardless of operational efficiency gains.
SVP is investing heavily (40% of portfolio) in "real assets, power plants, airplanes, real estate, toll roads." Khosla explicitly states, "We are not in the high knowledge growth game." This is a defensive rotation against AI disruption. While AI threatens "knowledge" jobs and SaaS cash flows, it cannot digitize a toll road, a power plant, or an airplane. Furthermore, AI data centers require massive amounts of power, creating a tailwind for power generation assets. LONG. These assets provide inflation protection and insulation from the technological deflation AI brings to software. A deep recession would lower demand for travel (airplanes) and energy (power), hurting cash flows despite their "real" nature.
Victor Khosla
Founder & CIO, Strategic Value Partners (SVP)
Khosla states, "If private equity firms have bought software businesses at 20 plus times cash flow relying on growth, you are going to see large pockets of problems." He notes that software is a "big stick" that could make the credit market buckle. The traditional LBO model for software relies on sticky, recurring revenue (seat-based pricing). AI agents and automation threaten to destroy this "knowledge work" pricing model. If revenue growth stalls or reverses due to AI efficiency, the massive debt loads placed on these companies by PE firms become unserviceable, leading to defaults that will hit Private Credit lenders and equity holders. SHORT / AVOID. High-valuation, high-debt software companies are the epicenter of the next credit cycle. AI adoption might be slower than expected, or software companies may successfully pivot to usage-based AI pricing models.
Victor Khosla
Founder & CIO, Strategic Value Partners (SVP)
Khosla observes, "High yield spreads today are 300... credit at 300 basis point spreads... is mispriced." He compares this to the 2015 energy crash where spreads blew out to 900 bps. A spread of 300 bps implies a benign economic environment, yet default rates are already at 6%. This is a pricing error. When the market realizes the "fat tail risk" (likely triggered by software/tech defaults), spreads must widen to compensate for the risk. Widening spreads mathematically equal falling bond prices. SHORT / AVOID. The risk/reward in high-yield credit is currently asymmetric to the downside. The Fed could cut rates aggressively, keeping zombie companies alive and spreads artificially tight.
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This Bloomberg Markets video, published February 25, 2026, features Victor Khosla discussing STEEL, XLI, ITB, POWER, IGV, BKLN, HYG, JNK. 4 trade ideas extracted by AI with direction and confidence scoring.
Speakers: Victor Khosla · Tickers: STEEL, XLI, ITB, POWER, IGV, BKLN, HYG, JNK