What is a BDC?


A BDC is a business development company. BDCs provide financing to small and midsize private companies. Formally speaking, most BDCs are closed-end funds that hold a portfolio of loans and trade on the stock market. BDCs distribute to their investors most of the net income from the private companies they lend to.

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

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

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