Staying the Course: Why Discipline Matters as Private Credit Expands
As private credit continues its rapid evolution into a mainstream asset class, managers are increasingly branching into new industries, deal sizes and structures in search of yield and growth. While that expansion can unlock opportunity, it also raises the risk of “strategy drift”—a gradual move away from the investment disciplines that historically drove performance.
Ted Denniston, Co-Head of NXT Capital, is closely watching how this dynamic is playing out across the market. With competition intensifying and certain sectors—particularly software—facing new uncertainty tied to AI-driven disruption, lenders may feel pressure to stretch beyond their core expertise. Denniston offers a perspective on how strategy drift manifests in real time, where risks are building beneath the surface, and why maintaining underwriting discipline remains critical to long-term performance.
CM: How do you define “strategy drift” in the context of private credit, and what are the earliest signs that a lender may be moving away from its core investment philosophy?
TD: Strategy drift is what happens when lenders gradually move away from their core investment discipline—often not by one big decision, but through a series of small compromises that add up. The earliest signs of strategy drift are subtle, changes in deal size, industry focus, origination approach, or structure that seem incremental, but collectively signal a departure from a firm’s original mandate.
CM: What are some of the most common ways you’re seeing strategy drift show up among lenders—whether through changes in deal size, industry exposure, or capital structure?
TD: We most often see strategy drift show up as lenders moving up or down market, expanding into unfamiliar industries, shifting how they originate deals, or loosening structural protections to stay competitive. Moving into a different part of the market isn’t just doing the same deal at a different scale; documentation, diligence, liquidity, and risk dynamics all change in meaningful ways.
While more aggressive structures can help win deals in the short term, they often weaken lender protections and delay the recognition of risk until conditions deteriorate. Overall, we believe when lenders move aggressively into sectors where they lack long‑standing experience, they’re often underestimating how differently those industries behave through a full credit cycle.
CM: How is the recent uncertainty in the software sector—particularly tied to AI disruption—impacting deal flow and underwriting confidence in what has traditionally been a core market?
TD: We see uncertainty around AI is dampening activity in the software sector, which has historically been a core source of deal flow—and that vacuum can increase the temptation for strategy drift elsewhere. As this void emerges, and the temptation for strategy drift may increase, it is even more important to understand each lender’s underlying investment approach and the consistency of its application over time.
CM: Beyond software, which sectors are most at risk of becoming overcrowded or mispriced, and where do you see the greatest potential for misallocation of capital?
TD: We’ve seen capital flow quickly into evolving or niche sectors like data centers or sports lending, and without deep sector expertise, that can lead to mispricing and misallocated risk. In our opinion, new entrants may face adverse selection or encounter limited control in a transaction.
CM: From a portfolio construction standpoint, how can managers ensure they are not unintentionally taking on correlated or misunderstood risks?
TD: Preventing unintended risk starts with discipline—clear mandates, strong governance, and consistent underwriting, which we believe matter more than reacting opportunistically to short‑term market shifts. Ultimately, actively monitoring adherence to investment mandates, ensuring strong governance, and maintaining a clear sense of organizational core competencies can help guard against unintentional drift. Each of these forms of strategy drift can quietly introduce new and sometimes hidden risks into a lender’s portfolio.
CM: Looking ahead, do you expect strategy drift to become a more significant issue across private credit, or will market conditions reinforce a return to core competencies?
TD: Market disruptions tend to test whether firms stay anchored to their core competencies or drift away from them—history shows it is discipline, not flexibility alone, that defines long‑term outcomes. The temptation for strategy drift may increase as lenders seek new avenues for growth, particularly amid heightened competition, muted deal flow, or the pursuit of enhanced economics, but the bottom line should be that when the market shifts, the principles don’t.
