See FAQs below.
What do BDCs do?
- They issue loans to small and middle-market non-public businesses
- They collect interest and fees on the loans they issue
- BDCs, given their status as registered investment companies under the Investment Company Act of 1940, are required to distribute at least 90% of their net investment income to shareholders
How can investors access BDCs?
- There are publicly traded and non-public BDCs. Investors can access them through direct investment or by owning their publicly listed equities
- When an investor purchases a BDC, they receive equity in the investment company. The underlying investment company owns a portfolio that is typically composed primarily of private market loans
What are the potential benefits of BDC exposure?
- Attractive yields: We expect yields will typically range from 8% to 10% (based on weekly yields over five years through August 31, 2022, tracked by Bloomberg, and the yield of the S&P BDC Index tracked by S&P)
- Portfolio diversification: Historically, low correlation to other asset classes
- Well positioned for differing rate environments: BDCs can balance their portfolios with diversified loan structures
- – Rising rates: Many BDCs issue floating-rate loans
- – Low rates: Many loans are structured with interest-rate floors or prepayment penalties
Regarding portfolio diversification, what is the correlation of BDCs to other asset classes?
- BDCs are equity securities, and they have the investment risks of equities. Although they offer attractive yields, they are not fixed income securities
Correlations: 3-year weekly correlations of total return, September 2018–June 2022
Source: Bloomberg, as of June 30, 2022. BDCs are represented by the S&P BDC Index; High-yield bonds by the ICE BofA U.S. High Yield Index; Equity REITs by the FTSE NAREIT All Equity REITs Total Return Index; Mortgage REITs by the FTSE NAREIT Mortgage REITs Property Sector Total Return Index; Russell 2500 Index by the Russell 2500 Total Return Index; Investment-grade bonds by the S&P 500 Investment Grade Corporate Bond Total Return Index; Leveraged loans by the S&P/LSTA Leveraged Loan Total Return Index; Emerging market bonds by the Credit Suisse Emerging Markets Corporate Bond Industrial Total Return Index; MSCI World Index by the MSCI World Net Total Return USD Index.
Past performance is not a guarantee of future results. Indexes are unmanaged and do not incur expenses. You cannot invest directly in an index.
What should investors know about how BDC expenses are disclosed for an investment vehicle that owns BDCs?
- A fund that invests in BDCs discloses BDC expenses as acquired fund fees and expenses (AFFEs). AFFEs, frequently seen in a fund-of-funds or similar vehicle, are fees associated with an underlying investment. They are shown as a line item in an expense table to distinguish them as fees of the underlying investment (in this case, the investment in the business development company) rather than the fund or vehicle.
- AFFEs are the result of a 2006 SEC rule intended to provide investors with increased transparency to see and understand expenses associated with underlying investments. The rule states that registered investment companies (or RICs, also often referred to as '40 Act Companies) are required to report proportional expenses of other RICs it owns as part of its own fees. A BDC fund discloses AFFEs because the BDCs it invests in are registered investment companies.
- AFFEs make the expense ratios look much higher for funds that invest in BDCs (or other RICs) compared with other equity funds. Investors need to remember that AFFEs are indirect expenses not borne by the fund, despite being listed in the fund's reported expense ratios.
- Fund shareholders do not pay proportional expenses/AFFEs when BDCs are held in a fund or ETF, despite AFFEs being included in the reported expense ratios. Instead, the BDC investment management fees are reflected in the total return of the BDC security, and thus also in the performance of the overall portfolio's performance. In other words, the impact of AFFEs is in the performance of the underlying security and the performance of the fund or ETF, not in the amount investors pay in expenses.
- Investors are impacted by direct expenses, such as management fees or other operating expenses. These do not include the AFFEs.
What are BDC risks to consider?
- BDC securities have interest-rate exposure, as their primary source of income is through loan issuance
- BDCs have credit risk, as some companies may default on their loans. BDCs lend to smaller, more capital-constrained companies. While BDC management teams evaluate the risk, the possibility of default exists
- BDC securities are equity securities and can lose value
For informational purposes only. Not an investment recommendation.
This material is provided for limited purposes. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Putnam product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice. The opinions expressed in this article represent the current, good-faith views of the author(s) at the time of publication. The views are provided for informational purposes only and are subject to change. This material does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Investors should consult a financial advisor for advice suited to their individual financial needs. Putnam Investments cannot guarantee the accuracy or completeness of any statements or data contained in the article. Predictions, opinions, and other information contained in this article are subject to change. Any forward-looking statements speak only as of the date they are made, and Putnam assumes no duty to update them. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those anticipated. Past performance is not a guarantee of future results. As with any investment, there is a potential for profit as well as the possibility of loss.
Diversification does not guarantee a profit or ensure against loss. It is possible to lose money in a diversified portfolio.
Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
Putnam Retail Management.