Putnam Investments is touting the benefits of business development companies, or BDCs, to advisors as a stable long-term investment vehicle that will withstand the turbulence of the coming markets.
A BDC is registered closed-end investment company that provides capital to mid-level companies, which range in EBITDA from $5 million to as high as $200 million. These companies range in assets from $5 million to as high as $200 million. The capital generally comes in the form of loans, according to Michael Petro, a portfolio manager at Putnam.
BDCs are an income generating product because they act similarly to a REIT. As such they do not pay any taxes at the corporate level, but in return they must pass along all their income to investors, Petro explained.
“Because BDCs have to pay out all their income in dividends, they have high dividends,” he said.
The firm released a report this month that Petro authored that lays out how the structure of BDCs, coupled with the possibility of a recession this year, will make BDCs a wise investment. The firm anticipates a recession but does not believe it will be all that long or deep and therefore predicts that BDC credit losses will not be significant, the report stated.
“We believe BDCs are fundamentally better prepared for an eventual recession than they have been in years past,” the report said. “We also believe that their dividend income would be largely preserved.”
The key to the BDC’s stability is in its diversification. Each vehicle can invest in up to 500 different companies throughout a variety of industries. With a net cast that wide, the chances of the BDCs failing are minimal, according to Petro. “BDCs have a lot of loans that are diverted across industries,” he said. “None of [them] are likely going to go bankrupt [although] the stocks could go down.”
“BDCs have a lot of loans that are diverted across industries,” he said. “None of [the businesses] are going to go bankrupt [although] the stocks could go down.”
They are also stable because they focus more toward first lien loans, which are safer than other loans. In addition, more recently BDCs have been concentrating on the larger companies which are more resilient during turbulent times, he said.
BDCs themselves have experienced their own problems over the years, according to Petro. About 15 years ago, they invested in riskier loans, their management teams were not as professional, and they were not as stable of a product. However, that has changed in the past few years, he said.
“Now they’re a lot more professionalized,” Petro said. “They want to present a safer and less volatile income stream to investors.”
Their management teams have improved significantly, and many are now investing in those first lien loans and larger and more stable companies, he said.
“Someone who needs no volatility in their equities [should invest in] Treasury bonds,” he said. “If you can tolerate those ups and downs while still setting that dividend income, then this might be a good product for you.”
Advisors looking to include BDCs in their portfolio should educate themselves on the variety of products, according to Petro. There are a variety of investment strategies, including those with various levels of risk, those with different levels of exposure to rate changes, and others that focus more on first lien loan, among other varieties.
“You have to understand each BDC individually to understand its management team, understanding its history, [and] its credit reward,” he said.