Newspaper article Sarasota Herald Tribune

Are Business Development Companies Returning to Favor?

Newspaper article Sarasota Herald Tribune

Are Business Development Companies Returning to Favor?

Article excerpt

THE RATIONAL INVESTOR

While interest rates have risen a bit from historical lows and are forecast to continue to rise, they still haven't provided much relief to investors who need income to pay bills. In their search for alternatives, some have stumbled upon a somewhat obscure class of securities called business development companies (BDCs).

BDCs were created by Congress in 1980 to stimulate investment in middle-market U.S. companies. These are companies that have earnings before interest, taxes, depreciation and amortization of $10 to $50 million. BDCs are traded on stock exchanges and they can pass through investment income without paying corporate income taxes. The investor pays any required taxes. In return for this generosity, the BDCs are required to invest at least 70 percent of assets in the non-public debt and equity of U.S. companies and annually distribute at least 90 percent of their income to stockholders.

A partial list of risks intrinsic to BDCs: underlying company credit and investment risk; leverage risk, as BDCs borrow money to make investments; illiquidity risk, as the underlying companies may have no ready market; capital markets risk, as BDCs rely on being able to easily borrow money to make new investments.

The 2016 performance of BDCs has been outstanding. The Wilshire Business Development Company Index gained 24.14 percent. While the Wilshire index shows the annualized three-year BDCs' total return is a lackluster 4.07 percent, its five-year total return is a reasonable 10.88 percent.

High dividend yield is a characteristic of typical BDCs. Over the last seven years, BDCs have generally been the highest yielding securities available. Historically, BDSs have yielded over 1.5 percentage points more than high-yield bonds and 7 percent more than 10-year U.S. Treasury securities.

While there's no way to be sure of future returns, a mathematical model developed by Cliffwater Advisory Services forecasts an annualized total return for BDCs of more than 9 percent, 2 percentage points higher than BDCs' closest competitor. …

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