Michael Forman, CEO of Franklin Square Capital Partners in Philadelphia, a leading sponsor of nontraded BDCs, says, "Nontraded BDCs offer the opportunity to invest in up and down markets." Although they are less liquid than traded BDCs, their longer time trajectory lets investments pay out over the long term. These asset classes were only previously accessible to institutional investors.
Some planners, nonetheless, favor traded BDCs. "With traded, there is an immense amount of disclosure and auditing, and shareholders wouldn't allow an out-of-line fee structure," says Jones of Gratus. "Why take the liquidity risk?"
WEIGHING THE BENEFITS
Planners trying to evaluate BDCs can find themselves hindered because few off-the-shelf tools analyze these structures, particularly if they are nontraded. Advisors suggest using some basics of investing, including assessing a manager's track record, investment strategy, mandate, as well as size of the company they are lending to. For a more quantitative approach, Jones compares both the cash flow basis and book value.
Although BDCs seem to promise high yields and stability, they have their skeptics. "There is no free lunch. If you are getting abnormal returns, you have to ask why," says Matthew Pieniazek, president of Darling Consulting Group in Newburyport, Mass. Although a BDC's reputation can be evaluated, the deals they invest in may be hard to judge. "It's tough to get your arms around the risks,'' he says. "Can an advisor look at clients and say they really know the risks they have accepted?" The client's risk tolerance and the relationship between risk and return must come into the investment equation, he says.
Planners may be tempted to wait and let the BDC market mature before investing. Over time, the risks will be clearer, and fees may also drop with increased competition. Lending markets, though, have been severely disrupted by the financial crisis and still aren't back to normal. BDCs are uniquely positioned to profit from this dislocation, filling the gap between lending demand and supply. This advantage could wane over time as markets return to normal.
Which is why some planners - a very small group, to be sure - are looking at BDCs for their clients' retirement income. As McMillan of Commonwealth says, "I think we are in a remarkable place in terms of credit markets, with lots of opportunities for nontraditional credit providers. Banks are still licking their wounds, which is why the BDC is interesting now."
David E. Adler writes regularly for Financial Planning and Barron's. His most recent book is Snap Judgment.
