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Home > Blog > Monthly Archives: March 2016

Monthly Archives: March 2016

U.S. Protection for Retirement Investors is on the Horizon

By early April, retirement investors will most likely be better protected. President Obama and his administration aim to complete a far-reaching rule holding retirement advisers to stricter standards. The proposed rules require brokers and financial advisers to act in the best interest of retirement savers, a higher standard than current regulations, which require only that advice be suitable. We will continue to update you on this developing ruling. Wall Street Journal writer Andrew Ackerman has more on the release of this news.

Business Development Companies (BDCs) – Are Astute Investors Heading for the Exits?

As reported by The Wall Street Journal on March 19, 2016 (“These High-Fee, Unlisted, Junk-Based Funds Aren’t Working Out”), investors who poured $22 billion into an obscure Wall Street investment product known as “Non-Traded Business Development Companies (BDCs)” are now pulling out record sums.

BDCs are built out of loans to small and medium-size companies with less than stellar credit, but are less transparent than regular mutual funds, typically make investors pay upfront fees of at least 10% and only accept withdrawal requests once a quarter.

According to an analysis reported by the WSJ, “the move to the exits is accelerating. Investors pulled $47.3 million out of nontraded BDC’s in the third quarter of 2015, up from $25.7 million in the second quarter” and “performance has been slipping, too. Across the industry, the value of the funds’ assets at the end of September was on average 16% lower than their initial offering price to investors.”

Non-traded BDCs were part of a fast-growing class of alternative, high-commission investments sold to individual investors in recent years. Marketing materials promised steady dividends, yields as high as 8% and a haven from volatile markets, according to fund documents and executives.

The fees, though, exceed those of most products pitched to retail investors. For example, one non-traded BDC, cited in the WSJ article, said in its disclosures that its 10% sales load and likely 2% offering expenses mean only $88 of every $100 of shares bought “will actually be invested in us…you would have to experience a total return on your investment of between 14% and 18% in order to recover these expenses.”

Meanwhile, “Wall Street continues to push the products while regulators are watching closely.” Paul Mathews, Finra’s vice president for corporate financing, was quoted in the WSJ article as having said the products are an ‘ongoing concern’ for the regulator and that ‘firms must ensure they are suitable for an investor’s risk profile and investment strategy.’

Part of what concerns regulators is that non-traded BDCs are being sold using many of the same networks of brokerage firms and typically charging the same high upfront commissions as non-traded real estate investment trusts – another product with a multitude of significant issues.

“It’s kind of like weeds,” said William Galvin, the top Massachusetts securities regulator. “You whack them in one part of the garden, but they come up in another.”

If you are an individual or institutional investor who has any concerns about your investment in any Business Development Company (BDC), please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Master Limited Partnerships (MLPs) – Income Tax Liabilities Could Decimate Investors

On March 9, 2016, the Wall Street Journal reported that investors in energy-related Master Limited Partnerships (“MLP Investors Face Tax Hit on Top of Big Losses”) face the prospect of “worse things than going to zero” as a prospective “wave of expected bankruptcy filings and debt restructurings could trigger taxes for investors at a number of energy firms”

Master Limited Partnerships (MLPs) are a corporate structure that do not pay any taxes at the corporate level, but instead pass along their income – and certain tax burdens – to shareholders.

Unfortunately, the “collapse in oil and gas prices has exposed the structure’s double-sided risk: Investors with potentially worthless shares – or units, as they are known – may nonetheless owe taxes on debt that is forgiven in a bankruptcy or an out-of-court restructuring” since “debt forgiven in a restructuring counts as noncash income, or cancellation of debt income, which creates a tax liability for investors without an associated cash distribution.”

As noted by the Wall Street Journal, “the roughly 60% plunge in oil prices since the summer of 2014 already has sent a number of energy companies into bankruptcy court, and more are expected to follow.”

Clearly investors have soured on MLPs, which sometimes yielded more than 10% a year at a time when Treasury bonds were yielding pennies on the dollar, as many of them have cut or halted their distributions to investors. For example, the “Alerian MLP Index, which tracks about 50 large energy partnerships, has lost nearly half its value over the past 18 months.”

Among the energy vulnerable MLPs cited in the article, whose “debt is trading at distressed levels,” are Linn Energy LLC (NASDAQ – LINE), Breitburn Energy Partners LP (NASDAQ – BBEP) and Atlas Resource Partners LP (NYSE – ARP).

Many retail investors clearly “weren’t told they were buying a high-risk product with potential tax traps” and a number of industry professionals openly have questioned whether MLPs should ever have been recommended to investors in an account that was not tax-deferred (such as a retirement account) which would have shielded them from the negative tax implications.

As Merrill Lynch recently noted in a February 17th research report (“Master Limited Partnerships: Malaise, Loathing, Pessimism”) which accompanied the downgrading of 7 MLPs, this is a “humiliated asset class” for which “the humiliation continues.”

For many retail investors, the question remains just how expensive will their financial humiliation ultimately be.

If you are an individual or institutional investor who has any concerns about your investment in any Master Limited Partnership (MLP), please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Fitch Rating Downgrades Hit Business Development Companies (BDCs)

Earlier this week, Fitch Ratings announced the completion of its periodic review of Business Development Companies (BDCs) – publicly traded firms that mostly make loans to mid-sized companies.

The review, which was comprised of 10 publicly rated firms, resulted in one-half of the 10 companies being either downgraded or otherwise assigned a negative outlook.

As noted by Fitch in its announcement, “Fitch’s outlook for the BDC sector is negative and reflects competitive underwriting conditions, earnings pressure, underperforming energy investments, unsustainable asset quality metrics, increased activist pressure, and limited access to growth capital. While some firms are better positioned, given their more conservative financial profiles and portfolio characteristics, others are likely to see rating pressure over the outlook horizon.”

Among the actions that were taken as a result of this peer review were the following:

– American Capital, Ltd. (NASDAQ – ACAS): Its ratings were placed on Rating Watch Negative;

– Apollo Investment Corporation (NASDAQ – AINV): Its Long-term Issuer Default Rating (IDR) was downgraded to ‘BBB-‘ from ‘BBB’ with a Rating Outlook of Negative;

– BlackRock Capital Investment Corporation (NASDAQ – BKCC): Its Long-term Issuer Default Rating was affirmed at ‘BBB-‘ with a Rating Outlook of Negative;

– Fifth Street Finance Corp. (NASDAQ:FSC): Its Long-term Issuer Default Rating was downgraded to ‘BB’ from ‘BB+’ with a Rating Outlook of Negative; and

– PennantPark Investment Corporation (NASDAQ: PNNT): Its Rating Outlook was revised to Negative from Stable.

If you are an individual or institutional investor who has any concerns about your investment in any Business Development Company (BDC), please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Business Development Companies – A High Wire Balancing Act Without A Safety Net?

A March 7th article in the Sarasota Herald Tribune (“Business Development Companies: Good Income Investment or Trap”) properly noted that, “in today’s historically low interest rate environment, investors hungry for higher yields have stumbled upon a somewhat obscure class of securities called Business Development Companies (BDCs).”

BDCs, investment entities that were created by Congress in 1980, are traded on stock exchanges and are required to invest at least 70 percent of their assets in the non-public debt and equity of small and middle-market U.S. companies. They annually distribute at least 90 percent of their income to stockholders.

Investors may be failing to appreciate that there are a number of risks intrinsic to BDCs, however, including their: 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; and capital-markets risk, as BDCs rely on being able to easily borrow money to make new investments.

The shorter-term performance of BDC’s has been disappointing with the average BDC down about 10 percent since the beginning of 2016, more than the S&P 500. The catalysts for this decline range from fears of rising interest rates to concerns about the soundness of their underlying investments.

Although, historically, BDCs have yielded over 1.5 percentage points more than high-yield bonds and 7 percent more than 10-year U.S. Treasury securities, BDCs are quite volatile investments compared with U.S. stocks in general and even more so with high-yield bonds. They have, for example, about 2.5 times the volatility of high-yield bonds.

Investors need to carefully analyze any BDC’s prospects before investing. Additionally, investors need to be confident they can deal with BDC’s high volatility. In short: BDCs are only suitable for aggressive investors.

If you are an individual or institutional investor who has any concerns about your investment in any BDC product, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).


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