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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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