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Software investors are finding out in 2026.

One simple way to see it is through IGV (the iShares Expanded Tech-Software Sector ETF), which gives a good snapshot of the software industry. In just the first two months of the year, it has fallen more than 20%, while the overall market has stayed roughly flat.

That’s a massive gap, and a sharp change in sentiment for a group of companies that have become Wall Street darlings after beating the market for much of the past 15 years. So, what changed? Is this remarkable run of outperformance finally coming to an end?

SaaS (software sold as a service) is probably the best business model of all time. A company can build a product, host it online, and charge customers again and again for access. Software businesses share a few characteristics that make them exceptional wealth-creating machines:

Most businesses have to fight for each new sale. Software is different. Once a customer signs up, that revenue often keeps coming back month after month, or year after year. That makes sales far more predictable than in most industries. And for investors, that kind of visibility is incredibly valuable.

Software businesses have the ability to grow 10% every year like clockwork. They might start by selling one tool to one team, then expand to more users, more departments, or more products. In other words, growth does not only come from finding new customers, but also from earning more from existing ones.

A manufacturer needs more factories, more machines, and more workers to produce more goods. Software does not. Once the product is built, serving one extra customer often costs very little. That means when revenue rises, profits can rise even faster. It is one of the few business models where success can turn into serious cash flow very quickly.

This is the hidden force behind everything above. Once a business relies on a piece of software, switching to another provider can be painful. It may be risky, expensive, time-consuming, or all three. Staff need retraining. Systems need to be moved. Important workflows can break. So even when customers complain, many still stay. Bad software businesses have have 90% retention rates.

For years, software looked almost unbeatable: steady growth, rising profits, and earnings that kept moving up and to the right. Investors poured into the sector and, in time, priced many of these businesses as if that success would continue without interruption.

AI has done one thing the market hates: it has introduced doubt.

Tools like ChatGPT and Claude are improving so quickly, and nobody really knows where the limits are. When people predict the gloomy future of software, three fears keep coming up again and again:

1. AI makes people more efficient

That’s the whole point, after all. But many software companies charge by “seat”, or in other words, by the number of employees using the product. If AI helps five people do the work that once took ten, companies may need fewer seats. That creates an awkward problem for software vendors: the more efficient their customers become, the harder it may be to keep growing revenue the old way.

2. AI makes software easier to build

Coding is getting faster and cheaper. That means new competitors can launch products more easily, and existing customers may start wondering whether they really need to pay so much for expensive tools they can build in-house.

3. AI may improve faster than most people expect

Humans tend to think in straight lines, but technology often moves in leaps. A task that might look impossible today can feel ordinary a few years later. So if AI is already good at research, writing, coding, and analysis, investors have to ask: what happens if it gets much better from here?

These concerns are real. Some software companies will feel the pressure more than others, and the ones facing genuine disruption deserve to trade lower. The same goes for businesses that were priced far too richly to begin with. But when fear takes over, the market often sells first and sorts out the details later. That’s when good businesses can get dragged down with the bad.

Despite all the doom and gloom, there are reasons to believe that SaaS is not dead.

The code itself was rarely the real moat. Plenty of famous products (think Facebook, Airbnb, and many others…) were built quickly in their earliest form. What made great software companies valuable was never just the ability to launch an app, it was the ability to turn that app into a reliable, trusted product that businesses could depend on for years.

A cheaper “AI-built” alternative may be able to copy the surface of a product, but not everything underneath it. Established software companies usually have access to more data, better integrations, stronger security, better support, and a track record that gives buyers confidence. For large companies, that’s what matters most. When a CTO chooses software, price is rarely the main consideration. Reliability, familiarity, and career risk often matter more.

Even if AI agents handle more tasks in the future, people will still need systems to guide them, monitor them, and set the rules. Businesses need interfaces, controls, workflows, and clear oversight. AI may change how software is used, but it does not automatically remove the need for software. If anything, the strongest platforms may become the place where AI gets embedded.

If AI reduces the value of charging by seat, vendors are unlikely to sit still. They may shift toward usage-based pricing, AI credits, outcome-based pricing, or entirely new models we have not seen yet. The business model can evolve, just as it has before…

Markets have a habit of declaring entire industries “finished” long before they actually are. History is full of moments when investors assumed a new threat would wipe out the old leaders, only to discover that the strongest businesses were far more adaptable than expected.

Think back to a few familiar examples:

When Amazon was reshaping shopping, many investors assumed physical stores were doomed. But the best retailers did not disappear, they adapted and thrived. Companies like Walmart and Target turned their store networks into a strength, using them to speed up delivery and offer same-day pickup. What looked like a fatal weakness became an advantage.

When cloud computing took off, many investors assumed legacy software companies would be left behind. Instead, leaders like Microsoft and Adobe changed with the times, shifted their business models to subscriptions, and ended up capturing a huge share of the value created by the very trend that was supposed to threaten them.

That is often how markets behave when uncertainty suddenly appears: they stop making fine distinctions. Investors sell first, then sort out the details later.

Part of the reason is simple: most of the money moving markets is playing a short-term game. Professional investors are judged every quarter, not every decade. They chase what is working, avoid what is falling, and cannot afford to look wrong for too long. Underperform your peers for a few quarters, and your investors might start running for the exit.

You can also add passive money to the mix (people buying index funds every month). These flows of money represent more than 50% of all market activity nowadays. Because of the way these funds are set up, more capital gets sent towards recent winners and less toward recent losers, further exaggerating short-term price swings. The result: what does well tends to get overpriced, and what does poorly tends to get unfairly punished.

These dynamics create opportunity for anyone willing to think further ahead. If you are making your investment decisions based on where a business could be in five or ten years, you are already playing a different game from most market participants. And that matters.

Valuations have fallen across the entire sector, pulling down good companies along with the bad. One of the iron laws in finance is that when valuations go down, future expected returns go up. It’s basic math.

So stick to the plan. Identify the companies that are unlikely to be harmed by AI, or may even benefit from it, and buy them while fear has made their prices more attractive. That’s exactly what we’re doing.

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