We are often asked for our thoughts regarding BDCs. Many investors find them attractive, but would like to know our team’s view before building them into their alternative allocations.
In our due diligence, the BDC space is currently an asset class where investors have to be a bit more discerning over the specific funds and managers that they’re aligning with.
On the manager side, we have seen quite a meaningful range in the quality of groups bringing BDCs to market.
Investor demand for these strategies grew in the low yield environment pre-2022. In response, we saw many firms launch BDC products. Many of the firms and teams managing these strategies had less experience than we typically like to see.
In terms of the portfolios, our two biggest hesitations around the BDC space in general have been the use of leverage and the fee burden.
On the leverage side, we typically see most BDCs run with 1-1.5x leverage, which in our view is quite meaningful for debt-oriented strategies.
Similarly, most BDCs charge their management fees on gross assets (inclusive of leverage) and have incentive fees that we feel are well above market for the type of exposure that is being offered in that specific BDC. Our view is that incentive fees of 20% for a ‘vanilla’ direct lending strategy is out of step with the underlying exposures.
Another item to note is the difference between private BDCs and publicly traded BDCs. Public BDCs typical trade fairly similarly to equities and allocators should be aware that they have historically exhibited high correlation to risky assets with significant downside volatility when liquidity dries up. This may not be the return profile that investors want from their alternatives sleeve.
As a firm, we do allocate to a handful of BDC’s but there are certainly considerations to be aware of before making an allocation decision in the space.
We hope this has been helpful and feel free to contact us to learn more about how we approach positioning portfolios.