is a BDC?
CHOKSI: A BDC, or business development company, is a type of corporate
structure created by Congress in 1980. It combined aspects of an operating
company and an investment company in a new type of closed-end fund. The
structure is designed to raise capital in the public equity markets and invest
that capital in debt and equity of private or illiquid small and medium-sized
domestic businesses in a pass-through entity vehicle. <
and Leverage Guidelines
BDCs were developed to provide individual and retail investors access to an
asset class that was typically only available to private investors and illiquid
fund-type structures. As a result, several structural safeguards are put in
place to reduce risk in the BDCs. Among those were reducing concentration risk
and funding risk.
have several rules that limit the amount of concentration risk in the portfolio
by forcing asset diversification, such as the limit that no single investment
can be greater than 25% of assets at fair value. The portfolio must also be
less than 50% positions that are individually greater than 5%. There's also a
limitation on the amount of control equity positions a BDC can have.
it comes to funding risk, BDCs are low-leveraged vehicles, particularly
compared to most other financial services companies. Leverage is limited to
one times debt-to-equity or a 200% asset-coverage ratio. What that means is,
for every dollar of equity that a BDC raises it can borrow an additional
dollar of debt and make two dollars’ worth of loans.
Because a business development company invests in the small and medium-sized
private businesses, one of the stipulations is that the BDC has to offer
managerial assistance to the companies that it invests in. That can come in
many forms, but it typically comes in the form of having board observation
rights, or outright sitting on the board for larger investments. If you think
about a BDC, they often help companies form their capital structure as well
as underwrite and originate the loans those companies use to finance their
growth. < /p>
Versus Externally Managed BDC
There are two types of management structures for a BDC: an internally-managed
BDC and an externally-managed BDC. For an internally-managed BDC, the
employees that make the investment decisions and run the day-to-day operations
work directly for the BDC. They receive a salary, bonus, and equity
compensation. Under an externally-managed structure, the employees that make
the investment decisions and run the day-to-day operations work for a third
party, the investment advisor, who provides its services to the BDC under an
external management agreement.
Managed BDC Fees
For an externally-managed BDC, the fee structure generally consists of a
management fee on assets under management, typically excluding cash, as well as
a performance-based incentive fee. All in, the expenses for a BDC typically
run around three to four percent of assets under management. <
The BDC industry has grown tremendously over the last ten years. In 2004,
there were a handful of BDCs. Total public equity in the sector was a
cumulative $5 billion. Recently, there were around 45 publicly-traded BDCs
that have raised a cumulative $28 billion in public equity, as well as a
handful of private, non-traded BDCs.
Treatment of BDCs
Many BDCs do elect to be treated as RICs, or regulated investment companies,
whereas, as long as they distribute over 90% of their taxable ordinary income
to shareholders as dividends, the income is only taxed once at the shareholder
level and not at the corporation level. So BDCs are really investing in
growing small and medium-sized private businesses and passing those cash flows
directly to shareholders.
the fixed-income world, the underlying assets that business development
companies invest in are most similar to either high-yield bonds or leveraged
loans. The underlying assets offer higher yields than those two asset classes
because the companies are small and medium-sized businesses. <
you think about the way a BDC generates alpha, it's often by taking illiquidity
risk, lending to a company that's too small to access the capital markets.
Many BDCs also structure their own loans. They capture premium from creating
a customized financing solution for the borrower, as well as developing a
relationship with that borrower.
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video's posting date. Video commentaries are general in nature and should not
be construed as investment advice. Opinions are subject to change with market
conditions. All performance information is historical and is not a guarantee
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Choksi is Senior Vice President of Finance and Head of Investor Relations at
Fifth Street Finance Corp. and is not involved in the portfolio management of
Van Eck funds.
note that Van Eck Securities Corporation offers additional investment products
that invest in the asset class(es) included in this video [Market Vectors BDC
Income ETF]. Important disclosure for BDC Income ETF Investors: Business
Development Companies (BDC) invest in private companies and thinly traded
securities of public companies, including debt instruments of such companies.
Generally, little public information exists for private and thinly traded
companies and there is a risk that investors may not be able to make fully
informed investment decisions. Less mature and smaller private companies
involve greater risk than well-established and larger publicly-traded
companies. Investing in debt involves risk that the issuer may default on its
payments or declare bankruptcy and debt may not be rated by a credit rating
agency. Many debt investments in which a BDC may invest will not be rated by
a credit rating agency and will be below investment-grade quality. These
investments have predominantly speculative characteristics with respect to an
issuer’s capacity to make payments of interest and principal. BDCs may not
generate income at all times. Additionally, limitations on asset mix and
leverage may prohibit the way that BDCs raise capital. The Fund and its
affiliates may not own in excess of 25% of a BDC’s outstanding voting
securities which may limit the Fund’s ability to fully replicate its index.
The Fund is currently concentrated in the financial services sector and may
depend, to a greater extent, on the overall condition of the sector. The
Fund may loan its securities, which may subject it to additional credit and
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dollar value of one share of the fund; it is calculated by taking the
total assets of the fund, subtracting total liabilities, and dividing by
the total number of shares outstanding. The NAV is not necessarily the
same as the ETF’s intraday trading value. Market Vectors ETF investors
should not expect to buy or sell shares at NAV.
Fund shares are not individually redeemable and will be issued and redeemed at
their NAV only through certain authorized broker-dealers in large, specified
blocks of shares called "creation units" and otherwise can be bought and sold
only through exchange trading. Creation units are issued and redeemed
principally in kind. Shares may trade at a premium or discount to their NAV in
the secondary market. You will incur brokerage expenses when trading Fund
shares in the secondary market. Past performance is no guarantee of future
results. Returns for actual Fund investments may differ from what is shown
because of differences in timing, the amount invested, and fees and
involves substantial risk and high volatility, including possible loss of
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