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I've been reviewing a lot of commentary by fund managers related to SaaS in the past few months and I've noticed something interesting. Currently there’s a growing narrative that the recent SaaS drawdown is due to the market believing AI will completely replace the SaaS business model. I think this is a fundamental misconception.
Institutional Rotation, Not Active Shorting:
Based on recent interviews by various investment managers, a clear consensus is forming: they aren't aggressively bearish on SaaS; they are just stepping away due to uncertainty.
For institutional investors, uncertainty is often treated mathematically the same as risk. When an investment manager builds a model for a SaaS company, AI introduces massive variability into the terminal value. Because managers can't confidently model out cash flows, they have to apply a higher discount rate, which fundamentally alters the intrinsic value of the stock today.
Because of this, institutions aren't necessarily saying the SaaS company is going to 0. They are saying this goes into the 'too hard' pile. They are taking their capital and rotating it into sectors with higher visibility. If institutions truly believed AI was going to completely obliterate traditional SaaS, we would see massive short interest and put-buying. We aren't. They are simply selling their long positions and walking away, leaving a vacuum of institutional buying power and driving down the price.
The Problem with Timing (Dead Money):
Many retail investors are holding SaaS because they believe the sector will recover. You might be completely right. But the fundamental problem with this trade is timing.
The market is currently forward-looking at the existential risk of AI. A good few quarters may not disprove the AI threat; it just shows the threat hasn't materialized yet. You could hold a perfectly healthy company for the next three years, watch its business grow, but watch its stock price trade entirely sideways because the multiple refuses to expand. That is the definition of "dead money."
What is the Catalyst for Recovery?
The perceived risk from AI is long-term, which puts a heavy ceiling on valuations. For multiples to expand again, there needs to be a definitive shift in market psychology. The broader market needs undeniable proof of one of two things:
\- AI will not replace SaaS workflows.
\- SaaS companies can successfully monetize AI as a structural tailwind.
Proving either of these things could take years, not months. The market needs time to believe the narrative has changed. This is why the recovery could be a slow grind, not a V-shaped bounce. Institutional investors aren't stupid; many of them know SaaS won't be replaced, but they also know it's not the most efficient place for their capital right now.
My Takeaway:
I think it's easy to get tunnel vision and ask purely whether this sector is undervalued. But institutional money doesn’t just screen for cheap multiples; they weigh opportunity cost and the timing of a catalyst. Regardless of your view on SaaS, you need instutional money to come back and they may not be back any time soon.
If you are holding SaaS right now, you should be deeply honest with yourself about the potential opportunity costs. Proceed with caution, and be mentally prepared to wait quite a while for the market's perception to catch up even if you end up being right.
PS: Nonetheless, I'm personally invested in SaaS right now. CSU and NOW are my picks as I view them as lower risk picks within the sector with asymmetrical risk-reward.