For the better part of two decades, software companies and information services firms have been rightfully viewed as the archetypal quality compounders. Once built, these businesses have been fortresses protected from competitive encroachment, resulting in significant pricing power and offering extraordinary incremental margins with returns on invested capital (ROIC) that only improve with scale. Furthermore, these businesses have taken share from the analog world, offering a seemingly endless runway for growth. As a result, software and information services companies have been accorded premium multiples by the market.
That playbook is now being stress-tested. The arrival of increasingly capable AI agents — from Anthropic’s Cowork and OpenAI’s Codex to OpenClaw — has prompted a broad selloff across software and information services stocks. In fact, the S&P 500 Software & Services Index, encompassing 140 companies, has fallen almost 25% year-to-date. The market is asking a deceptively simple question: If AI can replicate business logic, crawl public data, and compose user interfaces at near-zero marginal cost, what is the terminal value of a traditional SaaS subscription?
We believe the answer is nuanced. Not all moats are eroding equally, and the nature of competitive advantage is shifting in the AI era. Businesses that will compound value over the next decade are those that are investing aggressively today to build the moats of the future. Below, we share our evolving views.
Technology Companies: Capital Light to Capital Intensive
Gone are the days of exploding free cash flow and expanding margins for dominant technology companies known as hyperscalers. Long celebrated by investors for their capital efficiency, these technology behemoths are now some of the most capital-intensive businesses in the world, as they seek to dominate AI technology by building out the infrastructure to support large language models (LLMs) and the associated agents used by consumers and enterprises.
In fact, the five largest hyperscalers are projected to deploy over $700 billion in aggregate capital expenditure this year, an increase of over 60% from 2025. Most of them are expected to see a significant decline in free cash flow, which we believe will be temporary. In addition, a handful are taking on significant debt to finance their AI infrastructure buildout, and we are avoiding these companies. Newcomers like OpenAI and Anthropic are capital-intensive from the onset, burning cash at an unprecedented pace to build durable moats and network effects as well as grab a slice of the market from the formidable incumbents.
As investors increasingly question the ROIC of such massive cash outlays, there are a few useful precedents to look at. In 2015-2016, Amazon was criticized for spending aggressively on cloud infrastructure at the expense of near-term profitability. Amazon Web Services (AWS) ultimately generated substantial free cash flow, became Amazon’s most valuable and profitable business, and continues to lead in the AI era. Furthermore, Amazon also undertook other major investment cycles in the past to build out its now dominant retail and advertising businesses. Another precedent we would point to is Walmart, which went on a multi-year investment cycle to build out its ecommerce business and fortify its brick-and-mortar retail operations, resulting in record results over the past several years.
Today, the hyperscalers are making a similar wager that massive upfront capital deployment will yield durable competitive advantages in AI infrastructure that cannot be easily replicated. We are beginning to see some evidence of this: Google Cloud’s operating income grew a whopping 127% in the past year and its operating margin expanded from 14% to 24%, suggesting these investments are yielding great returns for Google. Similarly, Amazon’s AWS division saw revenue growth of 24% in the most recent quarter — the fastest growth in 13 quarters — while operating margin expanded to 35%.
The Asset-Light Software Model is Under Pressure
If high capital intensity is the story for large technology companies providing the AI infrastructure of the future, the story for software companies is one of gradual moat erosion. The traditional software business model — high gross margins, recurring subscription revenue, and high switching costs — faces a two-pronged challenge.
First, future growth is less certain due to AI disruption, with terminal values increasingly in question. AI agents can now replicate interfaces, encode business logic, and orchestrate workflows across tools in ways that diminish the value of a monolithic software bundle. Classic software moats are weakening. Learned interfaces — the keyboard shortcuts and specialized navigation that kept users locked into various software platforms — dissolve when the interface is simply a natural language conversation that novices can use. Business logic that took years of domain-expert engineering to encode in software can now be written in weeks. Public data access of large databases, once a genuine competitive advantage built on armies of custom document parsers, becomes trivial when the foundation model itself can evaluate and parse these databases in seconds.
Second, ROIC may start to erode as companies lose pricing power. AI has dramatically lowered barriers to entry for new software companies. Thousands of AI-native startups have emerged and received a record $150 billion in funding in 2025. They are tackling problems in different verticals and offering consumption-based pricing at steep discounts to existing subscriptions, eroding the revenue base for traditional software companies. While no clear winner has emerged, it is evident that the premium multiples investors once awarded to traditional software companies for pricing power and 90%+ retention rates can no longer be sustained.
But not all software moats are created equal, and we think it is a mistake to paint the entire sector with a single brush. A useful analogy is the media industry in the early 2000s. The advent of the internet eroded one of the most important moats that legacy media companies enjoyed: distribution. Many incumbents were disrupted. But those that owned truly proprietary content — or pivoted towards it, as HBO (part of Warner Bros.) and a handful of others eventually did — survived and in some cases thrived. A new class of internet-native winners like Netflix and Spotify emerged, distributing their content online directly to consumers. We see a similar bifurcation playing out today in software. The transition period for some will be long and painful, but we believe certain existing players will emerge stronger on the other side.
Reassessing Moats in the Age of AI
To understand shifting moats in the age of AI, it might be helpful to refer to Hamilton Helmer’s “7 Powers” framework, which is widely cited in business analysis. Helmer identified seven aspects of moats, namely Scale Economies, Network Economies, Process Power, Counter-Positioning, Cornered Resources, Switching Costs, and Branding. Some of these deserve more attention than others for the purpose of this analysis.
Cornered Resources have become increasingly valuable. Compute capacity and talent represent the defining cornered resource in this era. Amazon, Alphabet, and Microsoft are investing aggressively to corner available energy, industrial capacity, and semiconductor supply and doling out generous packages to recruit scarce AI talent.
Scale Economies remain powerful and are increasingly important for spreading out the costs of massive AI investments. Hyperscalers are able to amortize their infrastructure costs across their vast customer bases. The economics of training and deploying frontier AI models inherently favor scale — a dynamic that benefits foundational LLM companies like OpenAI with massive user bases — and will create barriers for smaller entrants.
Counter-Positioning is a highly relevant theme in the AI era. Companies like OpenAI and Anthropic and a swarm of AI-native startups have reinvented business models and scaled up at unprecedented speeds. Software is changing from subscription to consumption-based models. This challenges the well-entrenched incumbents, leaving them with a classic dilemma: engage in creative destruction and thus cannibalize the current revenue base, or try to protect the current business and extract maximum cash flows in the face of a secular threat.
Switching Costs warrant a completely new lens for analyzing certain industries. Software companies that have long prided themselves on the stickiness of their workflows are now seeing those workflows increasingly challenged by AI-native startups. When AI agents can rewrite and migrate legacy databases and workflows in days rather than months, the friction of switching diminishes materially.
Equity Positioning: Where We See Durable Quality Growth
The shifts in moats discussed above have real implications on how we construct our equity portfolio, which is focused on quality growth. We are increasingly distinguishing between businesses whose moats are unaffected or reinforced by the AI transition, and those whose moats are threatened by it.
We are overweight the industrial economy, reflecting our view that physical-world moats built through sustained capital investment are becoming more, not less valuable. For companies in the aerospace and rail industries, decades of accumulated capital, engineering expertise, and regulatory requirements have created barriers that AI cannot easily overcome. These businesses benefited tremendously from scale economies and cornered resources that have been built up over generations.
We are also overweight health care. In pharmaceuticals, patents remain the ultimate cornered resource as leading pharmaceutical companies derive their competitive position from molecules that cannot be replicated until patents expire.
Within technology, we favor the infrastructure layer over the application layer. Although current free cash flow challenges warrant close attention, we believe that the ongoing investment cycle from hyperscalers will ultimately translate to accelerating revenue growth and expanding margins, creating widened scale advantages and generating long-term value. We also remain constructive on semiconductor leaders, particularly those with process power and cornered resources in advanced chip design and manufacturing – the kind of moat that takes decades to build and cannot be replicated through software alone.
In software and information services, we are more selective. We favor companies with truly proprietary data assets, regulatory lock-in, and deeply embedded, critical workflows. We are cautious on companies built around public data curation, workflow automation, or business logic that AI agents can increasingly replicate.
Fixed Income Positioning: Playing Defense, Buying Opportunistically
In our fixed income portfolio, we remain patient, opportunistically buying on weakness and keeping plenty of dry powder. The composition of the traditional high yield market has changed in recent years, primarily due to the advent and strong growth of private credit. As a result, the public high yield market is much higher quality, with an approximately 60% weighting in BBs, the highest rating, while CCCs have declined to less than 10% of the market. We believe this should significantly reduce volatility going forward while still preserving the opportunity to earn attractive yields.
We have been increasingly defensive given geopolitical events, and our short-term fixed income investments continue to deliver solid returns. We have been selectively adding longer-dated bonds, but we feel now is not the time to trade down in quality to capture more yield. Likewise, we have always maintained modest exposure to software, largely because most software companies do not issue high yield bonds, and the issuers who do use high yield are generally the result of a leveraged buyout (LBO), which we tend to avoid.
Final Thoughts
We continue to apply our quality growth framework to managing portfolios, as we believe owning high quality businesses with strong incremental returns on capital that can compound free cash flow over time should translate to outperformance in the long run.
What is evolving is our definition of a durable competitive advantage, which we have always believed is an essential element of a quality company. The asset-light, high-ROIC model that defined software investing for a generation is not dead, but it is no longer sufficient. In the age of AI, investors must evaluate not just whether a business generates strong returns today, but whether its competitive moat is widening or narrowing, and whether its position is reinforced or undermined by the broader shift toward capital intensity.
To evaluate the structural durability of a company’s competitive advantages, we now seek moats rooted in physical assets, proprietary data, network effects, regulatory lock-in, and large scale capital investment. We are willing to accept temporary declines in free cash flow when companies are investing to build or reinforce their moats, as we believe that free cash flow should eventually improve and grow as their structural advantages compound.
As always, we thank you for your continued confidence in our management.
John Osterweis
Founder, Chairman & Co-Chief Investment Officer – Core Equity
Gregory Hermanski
Co-Chief Investment Officer – Core Equity
Nael Fakhry
Co-Chief Investment Officer – Core Equity
Carl Kaufman
Co-President, Co-Chief Executive Officer, Chief Investment Officer – Strategic Income & Managing Director – Fixed Income
Featuring
John Osterweis
Founder, Chairman & Co-Chief Investment Officer – Core Equity
John Osterweis founded Osterweis Capital Management to serve the portfolio needs of high-net-worth investors, foundations, and endowments. He is currently Chairman of the firm as well as a member of the firm’s Management Committee and a Portfolio Manager for the core equity, growth & income, and flexible balanced strategies.
After graduating from business school, John served as a Senior Analyst concentrating on the forest products and paper industry for several regional brokerage firms and later for E.F. Hutton & Company, Inc. In addition to his activities as an analyst, John served as Director of Research for two firms and managed equity portfolios for over ten years. In late 1982, John decided to devote himself full time to his portfolio management activities, and in April of 1983 launched Osterweis Capital Management.
John graduated from Bowdoin College (B.A. in Philosophy, cum laude), and Stanford Graduate School of Business (M.B.A. with top honors in Finance).
Outside of his work, John is an active supporter of our community. He has served as Director of the Lucas Museum of Narrative Art, Director on the Stanford Alumni Association Executive Board, Trustee of Bowdoin College, Director and Vice Chairman of Mt. Zion Hospital and Medical Center, and President of the Board of Directors for Summer Search Foundation. He currently serves as a Trustee of the San Francisco Ballet Association, Director of the San Francisco Free Clinic, and President Emeritus of the San Francisco Ballet Endowment Foundation, as well as Trustee Emeritus of Summer Search Foundation and of Bowdoin College. He also enjoys horseback riding and other outdoor activities.
Gregory Hermanski
Co-Chief Investment Officer – Core Equity
Greg Hermanski, a partner at Osterweis, is a Portfolio Manager for the core equity, growth & income, quality cyclical growth, and flexible balanced strategies. He enjoys working with his team to protect and grow our clients’ wealth. Greg feels that humility and discipline are key to succeeding in this industry and loves the continuous chance to learn as part of his role.
Prior to joining Osterweis in 2002, Greg was a Vice President at Robertson Stephens and Co. where he was in charge of convertible bond research. Prior to that, Greg was a Research Analyst covering convertible, high yield, and distressed securities at Imperial Capital, LLC, and a Valuation Consultant for Price Waterhouse, LLC.
Greg graduated from the University of California, Los Angeles with a B.A. in Business/Economics. Outside of work, he enjoys traveling, mountain biking, running, reading, and learning about history.
Nael Fakhry
Co-Chief Investment Officer – Core Equity
Nael Fakhry, a partner at Osterweis, is a Portfolio Manager for the core equity, growth & income, quality cyclical growth, and flexible balanced strategies. He loves the process of researching companies and studying the history of various industries.
Prior to joining Osterweis Capital Management in 2011, Nael worked as an Associate at American Securities, a private equity firm, and as an Analyst in the investment banking division of Morgan Stanley.
Nael graduated from Stanford University with a B.A. in History, Phi Beta Kappa and the University of California Berkeley, Walter A. Haas School of Business with an M.B.A., where he was a C.J. White Scholar. Outside of his professional life, Nael enjoys coaching his kids’ soccer and basketball teams, reading, and running. He also contributes to the community as Treasurer and member of the Board of Directors of the Burlingame Community Education Foundation, where he supports local education and helps manage the endowment.
Carl Kaufman
Co-President, Co-Chief Executive Officer, Chief Investment Officer – Strategic Income & Managing Director – Fixed Income
Carl Kaufman
Co-President, Co-Chief Executive Officer, Chief Investment Officer – Strategic Income & Managing Director – Fixed Income
Carl Kaufman serves in several key roles for the firm. He has managed the Osterweis Strategic Income Fund since its inception and serves as the Managing Director of Fixed Income, as well as a Portfolio Manager for the Osterweis Growth & Income strategy. Additionally, in his role as Co-President & Co-CEO he oversees key investment matters and is an integral part of the firm’s Management Committee.
He joined Osterweis Capital Management in 2002, after nearly 24 years at Robertson Stephens and Merrill Lynch.
Carl graduated from Harvard University and attended New York University Graduate School of Business Administration.
Outside his professional endeavors, he enjoys playing classical piano and actively contributes to the community as a member of the Board of Trustees for the San Francisco Conservatory of Music, supporting the arts and enhancing the cultural fabric of the SF Bay Area. Additionally, he enjoys playing golf, an activity that continually challenges his patience and precision.
For more information about this strategy, please send us an email or call us at (800) 700-3316.
Related Insights
Growth & Income Fund Quarter-End Performance (as of 3/31/26)
| Fund | 1 MO | QTD | YTD | 1 YR | 3 YR | 5 YR | 7 YR | 10 YR | 15 YR |
INCEP (8/31/2010) |
|
|---|---|---|---|---|---|---|---|---|---|---|---|
| OSTVX | -4.33% | -2.13% | -2.13% | 9.76% | 9.68% | 5.61% | 8.54% | 8.60% | 7.86% | 8.70% | |
| 60% S&P 500 Index/40% Bloomberg U.S. Aggregate Bond Index | -3.69 | -2.62 | -2.62 | 12.35 | 12.36 | 7.41 | 9.40 | 9.26 | 9.04 | 9.71 | |
| S&P 500 Index | -4.98 | -4.33 | -4.33 | 17.80 | 18.32 | 12.06 | 14.44 | 14.16 | 13.29 | 14.56 | |
| Bloomberg U.S. Aggregate Bond Index | -1.76 | -0.05 | -0.05 | 4.35 | 3.63 | 0.31 | 1.56 | 1.70 | 2.39 | 2.25 | |
Gross expense ratio as of 3/31/25: 0.91%
Performance data quoted represent past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be higher or lower than the performance quoted. Performance data current to the most recent month end may be obtained by calling shareholder services toll free at (866) 236-0050.
Rates of return for periods greater than one year are annualized.
Where applicable, charts illustrating the performance of a hypothetical $10,000 investment made at a Fund’s inception assume the reinvestment of dividends and capital gains, but do not reflect the effect of any applicable sales charge or redemption fees. Such charts do not imply any future performance. During the period noted, fee waivers or expense reimbursements were in effect for the Growth & Income Fund.
Source for any Bloomberg index is Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg owns all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.
The 60/40 blend is composed of 60% S&P 500 Index (S&P) and 40% Bloomberg U.S. Aggregate Bond Index (Agg) and assumes monthly rebalancing. The S&P is widely regarded as the standard for measuring large cap U.S. stock market performance. The Agg is widely regarded as a standard for measuring U.S. investment grade bond market performance. These indices do not incur expenses and are not available for investment. These indices include reinvestment of dividends and/or interest income.
References to specific companies, market sectors, or investment themes herein do not constitute recommendations to buy or sell any particular securities.
There can be no assurance that any specific security, strategy, or product referenced directly or indirectly in this commentary will be profitable in the future or suitable for your financial circumstances. Due to various factors, including changes to market conditions and/or applicable laws, this content may no longer reflect our current advice or opinion. You should not assume any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from Osterweis Capital Management.
Complete holdings of all Osterweis mutual funds (“Funds”) are generally available ten business days following quarter end. Holdings and sector allocations may change at any time due to ongoing portfolio management. Fund holdings as of the most recent quarter end are available here: Growth & Income Fund
As of 3/31/26 the Osterweis Growth & Income Fund did not hold positions in Walmart, Netflix, Warner Brothers, Spotify, Meta, OpenAI, Anthropic, or Oracle.
The Osterweis Funds are available by prospectus only. The Funds’ investment objectives, risks, charges, and expenses must be considered carefully before investing. The summary and statutory prospectuses contain this and other important information about the Funds. You may obtain a summary or statutory prospectus by calling toll free at (866) 236-0050, or by visiting www.osterweis.com/statpro. Please read the prospectus carefully before investing to ensure the Fund is appropriate for your goals and risk tolerance.
Mutual fund investing involves risk. Principal loss is possible.
The Osterweis Growth & Income Fund may invest in small- and mid-capitalization companies, which tend to have limited liquidity and greater price volatility than large-capitalization companies. The Fund may invest in foreign and emerging market securities, which involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks may increase for emerging markets. The Fund may invest in Master Limited Partnerships, which involve risk related to energy prices, demand and changes in tax code. The Fund may invest in debt securities that are un-rated or rated below investment grade. Lower-rated securities may present an increased possibility of default, price volatility or illiquidity compared to higher-rated securities. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. From time to time, the Fund may have concentrated positions in one or more sectors subjecting the Fund to sector emphasis risk. Investments in preferred securities typically have an inverse relationship with changes in the prevailing interest rate. Investments in asset-backed and mortgage-backed securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments.
Investment and insurance products are not FDIC or any other government agency insured, are not bank guaranteed, and may lose value.
No part of this article may be reproduced in any form, or referred to in any other publication, without the express written permission of Osterweis Capital Management.
This commentary contains the current opinions of the authors as of the date above, which are subject to change at any time, are not guaranteed, and should not be considered investment advice. This commentary has been distributed for informational purposes only and is not a recommendation or offer of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Return on invested capital (ROIC) is a calculation used to assess a company’s efficiency at allocating the capital under its control to profitable investments.
Free cash flow represents the cash that a company is able to generate after laying out the money required to maintain and expand the company’s asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value.
Capital expenditures (CapEx) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment.
A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans, along with the assets of the acquiring company.
Yield is the income return on an investment, such as the interest or dividends received from holding a particular security.
Investment grade/non-investment grade (high yield) categories and credit ratings breakdowns are based on ratings from S&P, which is a private independent rating service that assigns grades to bonds to represent their credit quality. The issues are evaluated based on such factors as the bond issuer’s financial strength and its ability to pay a bond’s principal and interest in a timely fashion. S&P’s ratings are expressed as letters ranging from ‘AAA’, which is the highest grade, to ‘D’, which is the lowest grade. A rating of BBB- or higher is considered investment grade and a rating below BBB- is considered non-investment grade (high yield). Other credit ratings agencies include Moody’s and Fitch, each of whom may have different ratings systems and methodologies.
Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [OCMI-908735-2026-03-30]
