Business Development Companies: A Primer With 2 Warnings

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Business Development Companies: A Primer with Two Warnings

By Don Chambers, September 2020

This article starts with a primer and ends with two warnings about BDCs (Business Development Companies) that may shock even seasoned investors. Investors considering the addition of a BDC to their investment portfolios should read all of this article and do extensive research on corporate governance before buying their first BDC share.

A PRIMER ON BDCs:

The first half of this article reviews the basics on BDCs in order to lay a foundation for better understanding the warnings that are laid out in the second half of the article.

Overview of BDCs: Legislation enabling Business Development Companies ((BDCs)) was passed in 1980 to spur creation of small businesses and the growth of those businesses. Although BDCs can be private entities (i.e., not listed on any exchanges), this article focuses on BDCs that are listed on the NYSE or NASDAQ. While most private BDCs have limited lifetimes (liquidating in perhaps 7 years or so), listed BDCs usually are designed to live on in perpetuity.

BDCs are very similar to “middle-market private equity firms.” BDCs invest in “portfolio companies.” The BDC investment can be of three possible types. The first type of BDC investment is in the equity of a portfolio company. The second type of investment is in the debt of a portfolio company. The third type of investment is in a hybrid security, a security that has some equity-like features and some debt-like features. One example of a hybrid security is convertible debt. There are many different ways that a hybrid security can be structured. BDCs that invest in debt securities and hybrid securities are generally known as “lending-based” BDCs

This article focuses on small, lending-based BDCs because most BDCs are small and most small BDCs are lenders.

BDCs as Closed End Funds: Unlike traditional mutual funds in which shareholders can easily buy and sell shares at or near the fund’s underlying per-share value, BDCs are organized as closed-end funds. The reason is that most BDC assets are illiquid. So rather than buying or redeeming your shares through the fund, shareholders wishing to enter or exit positions must buy or sell their shares in the market. The closed end structure protects the BDC from needing to sell illiquid assets at distressed prices to meet shareholder redemptions.

Traditional mutual funds without sales loads generally allow shareholders to enter and exit funds at the fund’s net asset value (NYSE:NAV), which is the fund’s asset value minus its indebtedness. NAVs can be expressed for the assets of a fund as a whole (e.g., $105 million) or on a per share basis (e.g., $10.00 per share) which is simply found by dividing the fund’s NAV by the number of shares.

The NAV of a fund with listed securities as assets provides an important indication of the fund’s true portfolio value because it is calculated based on market values. For a BDC or other fund with large holdings of unlisted securities, the values of the securities are professionally estimated at least once per year. These estimates of the value of unlisted securities may be unreliable. Since BDCs hold mostly unlisted securities, the decisions on how to calculate the asset values are critical because the managerial fees paid from the fund to the investment manager are based on those values. This raises an important potential conflict of interest discussed in subsequent sections.

Potential Economic Benefits of Being a BDC: The primary reason to organize as a BDC is to enjoy the income tax benefits of not having to pay income taxes at the “BDC level”. In other words, the BDC entity itself is not subject to corporate income tax like a normal operating company (i.e., a C corporation). Rather, like most mutual funds, the income flows through to the investors. The benefits may include tax-reporting based on 1099s (not the dreaded K-1’s), protection from UBIT (unrelated business income tax) and protection from filing state income tax returns in numerous states.

Potential Economic Costs of Being a BDC: Accessing private equity through BDCs rather than limited partnerships can have adverse tax consequences to taxable investors. Private partnerships are often termed “transparent” tax entities in that they can allow tax benefits such as depreciation and depletion to flow through the partnership into the individual tax returns of the investors via K-1s.

Additionally, BDCs must abide by a number of requirements which – roughly stated – include: (1) a large portion of a BDC’s annual gross income must consist of dividends, interest and gains from investing in securities and must be distributed to its shareholders each year, (2) the BDC’s portfolio of investments must meet certain diversification tests, (3) the BDC’s leverage is limited, and (4) much of each BDC’s assets must be in privately issued securities of small U.S. firms to which the BDC makes available significant managerial assistance. Listed BDCs are also subject to requirements including the filing of various financial statements.

Net Asset Values and BDC Discounts: As indicated above, the NAV of a BDC largely relies on subjective and potentially biased valuations of the BDC’s illiquid investments because most BDC assets are unlisted and therefore do not have readily observable market prices.

Assets can be viewed as belonging in one of three categories: Level 1 assets (with readily observable market values), Level 2 assets (with values that can be well-estimated using well-developed models and observable data), and Level 3 assets with values that must be professionally estimated based on unobservable inputs [see Endnote 1 for additional information].

BDCs portfolios contain mostly Level 2 and Level 3 assets which increases the potential for overstated values since management fees are generally determined as a set percentage (e.g., 2% per year) of the gross asset value.

As with other closed-end funds, BDC market values are often expressed relative to their NAVs as percentage discounts (or, less often, premiums). For example, a fund with a per share net asset value of $10 and a market share price of $8.50 would be described as trading at a 15% discount.

Many analyses of BDC attractiveness or performance are based on the level and behavior of its “discount” – which would be more formally described as the discount of the market price of the BDC shares to the most recently reported NAV per share. For example, here is a partial screenshot [see Endnote 2] of descriptive statistics regarding BDCs including discounts and premiums.

Exhibit #1: Screenshot of BDCs from Closed-End Fund Advisors

(For a less detailed, easier to read screenshot go to the end of this document)

Note in the first row of data that a price of $8.92 for a fund with an NAV per share of $15.29 generates a discount of -41.66%, found as: 1- (8.92/15.29). Note that in the case of BDCs, the NAVs are estimated infrequently (e.g., quarterly) and are published on a delayed basis.

Nevertheless, a discount of roughly 40% provides an initial impression that the BDC can be purchased at 60% of its true value. But are the assets really worth $15.29 per share and how much of the annual cash flows from those assets end up in the pocket of managers rather than investors? Those are the key questions.

Potential Conflicts of Interest between Fund Managers and Shareholders: While the concept of BDCs was created to spur entrepreneurial ventures, individual BDCs, like most public investment funds, are created to generate revenue for the people organizing and managing them. BDC managers are generally compensated via management fees on gross assets – assets that are often valued based on a process overseen by the managers themselves.

Obviously, managers are incentivized to invest wisely and to drive the true value of the fund’s net assets higher. But managers may also be incentivized to pursue higher fees at the expense of shareholders. Consider the following three major potential conflicts of interest:

1. Managers may invest in too many assets: Most BDCs provide an incentive for managers to over-invest in gross assets because their management fees are typically based on total gross assets rather than net assets or equity. See “Fair Valuation and Mutual Fund Directors: Alternative Approaches to Valuation” [Endnote 3] for details on the practices and trends in BDC fees including the assessment of fees based on gross rather than net asset values.

2. BDCs may have overstated asset values: BDCs compensate managers based on professionally estimated asset values rather than the market values implied by the market price of the BDC’s equity. Portfolios containing Level 3 assets are especially susceptible to valuation problems from conflicts of interest.

3. BDCs may select overly-aggressive investments: BDCs generally offer managers incentive fees that allow them to share substantially in upside performance (without similarly sharing in downside performance). This asymmetric fee structure may be viewed as providing payouts to managers similar to a long position in a call option on the BDC’s assets. For further information see Lovell and Mahon [see Endnote 4]. This asymmetrical payoff structure can incentivize managers to invest in portfolio companies with very high potential profits even though their probability of failure is high. Much more about incentive fees is discussed near the end of this article.

Governance Issues with BDCs: The potentially serious conflicts of interest between BDC managers and BDC shareholders means that corporate governance is of great importance. The fact that most listed BDCs have unlimited lives means that governance issues are especially important because shareholders do not have an automatic liquidation point to escape from governance problems.

Because BDCs are closed end funds, shareholders may trade with other investors, but they cannot redeem their shares with the fund. Thus the managers of BDCs have, in effect, a captive shareholder base and source of fees. It is difficult in the short-run to identify which BDC managers are effective enough to deserve their high fees. Eventually evidence may indicate that the fund is worth more via a liquidation.

The antidote to overpaid and poor managers is shareholder activism. Activists buy BDCs and other closed end funds at large discounts and assert shareholder rights in efforts to exit their investments at or near NAV. A good shareholder activist seeks long-term benefits for all fund shareholders by identifying managers who generate much higher costs to the fund than benefits. While the goal of activists is generally self-seeking, they can play a valuable role in promoting economic efficiency and discouraging excessive compensation among fund managers.

To avoid funds with entrenched managers that are unlikely to serve shareholder interests well, study the fund’s provisions before establishing a position. Investigate whether the has instituted anti-takeover defenses such as being organized in Maryland [see Endnote 5] or having a staggered board in which only a few Directors are elected each year. A history of low dividends or no dividends is a signal that managers are focusing too much on keeping value inside the fund so that they can collect higher fees. Managerial reluctance to repurchase substantial quantities of shares when they are trading at a large discount is another sign that managers are more concerned about collecting large fees than generating attractive returns for shareholders.

Consider the following illustration of the association of fund discounts with high management fees and other expenses when the manager lacks exceptional asset selection skill:

Discount = Net Asset Value – Share Price = Present Value of Fees and other Expenses

The above equation indicates that a BDC’s discount (expressed in dollars) equals the amount of the fund’s net assets that are expected to flow to stakeholders other than the shareholders. It’s pretty simple: in the long run the BDC’s net asset value gets divided between the shareholders and others.

Shareholder Knowledge and Involvement is Essential: There is a proverb in poker that if you are in a poker game for more than 30 minutes and have not figured out who the sucker is – it’s you. Being successful in BDCs and other closed-end fund investing requires diligent analysis to separate the good deals and the good guys from the bad deals and the bad guys. Investors should not assume that regulations will protect them from managers who place their interests far above shareholder interests. For example, see [Endnote 5] for a summary of ways that managers can serve their interests over shareholders by forming the fund under Maryland law.

Analysis of BDCs should be evidence-based and rely on long-term data. In the case of fund managers in disputes with activist shareholders, investors should thoughtfully examine both the reports by the managers and the activists to decide: (1) whether their assertions are logical, and (2) whether their arguments are supported by long-term risk-adjusted performance rather than by analyses that have been “cherry-picked” to prove a point. Reliable performance analyses are based on the market values of the BDC, not the NAVs, because market values reflect consensus estimates of long-term values while NAVs are unadjusted for anticipated expenses and, especially in the case of BDC’s with unlisted assets, can be subjective and distorted by conflicts of interest.

There are some funds that are unattractive at almost any discount because the cash from the assets is drained out by greedy managers while the shareholders are left with meager dividends or even no dividends. These funds often have strong barriers against shareholder activism and serve more as ATMs for the fund managers than as reasonable investments for shareholders.

Three Takeaways from the above Primer for BDC Investors: Much needs to be learned in order to select and manage a successful portfolio of BDCs or other closed end funds. As a starting point, consider these three takeaways:

1. Never buy a listed BDC or ordinary closed-end fund as part of its initial offering. When offering expenses and sales commission are included, buying at the initial offering means buying at a substantial premium – not a discount – and likely guaranteeing poor immediate returns.

2. Select seasoned funds that are trading at discounts much greater than is explained by fund expenses and that have long-term evidence of benefiting from reasonably skilled investment managers. Attractive discounts are best found during market crises. One potentially valuable strategy is to very patiently wait for a serious market crisis and buy only when discounts are huge (and only those funds that are shareholder-friendly). This requires the patience to mostly sit on the sidelines when discounts are merely large enough to offset high fund fees and expenses.

3. If a BDC or other closed end fund that you hold becomes the subject of activism take the time to study very carefully the arguments presented by the activists and those presented by the fund managers. One or both sides will be relying on misleading statistics or arguments. Both sides are subject to potential conflicts of interest. Only support the side, if any, that takes the time to carefully provide and explain persuasive long-term, evidence-based facts for their position.

TWO WARNINGS ON BDC INVESTING:

The first half of this article reviews the basics on BDCs in order to lay a foundation for better understanding the warnings that are laid out in this second half of the article.

WARNING #1 ON BDC INVESTING: MANY BDCs ARE “FEE TRAPS”

From “Day One” many BDCs – if not most – are designed to trap investors into paying enormous fees with little or no escape other than selling at large discounts to NAV.

Forty years ago Federal courts ruled that a fund’s fee violates certain regulations only when its fees are “so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining” [see Endnote 6]. This dubious legal standard is known as the Gartenberg Standard (from the name of a litigant) and is often cited to justify fee levels that allow BDCs and other funds to charge exorbitant fees to unwitting shareholders. The result is often massive discounts of share prices relative to net asset values that reflect the enormous fees that drain asset value from shareholders to managers.

Beware of BDCs organized in Maryland

Wilson [see Endnote 7] provides an articulate description of the “…options available to boards of directors of closed-end funds formed as Maryland corporations” in light of shareholder activism that Wilson argues “…focus on short-term gains [that] can be at the expense of the long-term strategy preferred by many retail stockholders”. Financial economists argue that market values reflect all potential future cash flows and that short-term gains align well with long-term stockholder preferences.

Wilson notes that “… a director of a Maryland corporation is not required to act solely because a proposed action would result in a reduction of the current discount to net asset value or otherwise increase the trading price of the stock of the corporation.”

Many of the BDC protections against activism that are discussed in the next section are made available by organizing the BDC in Maryland rather than a different state such as Delaware. Although investors should be aware that states other than Maryland may have regulations that allow funds to engage in behaviors that harm shareholders.

Beware of BDCs with bylaws that provide protections for managers

Staggered Boards of Directors elect some Directors each year rather than all Directors. The effect on activists is to require the activist to launch several annual campaigns to change control of the Board. Activist campaigns to change the Board of Directors (via “proxy contests”) can be very expensive. Activists must mail and otherwise contact shareholders sometimes without direct access to their contact information. Entrenched management has numerous options to make life difficult and expensive for those who would seek to change the fund’s leadership. Worse yet it is with the shareholders’ money that management is able to fund the costs of defending against shareholder activism.

Poison Pills are actions such as issues of new shares or other securities that can dilute control by existing activist shareholders. Wilson notes that “In Maryland, a board of directors has the authority to authorize and issue stock, options, and warrants that are necessary to implement various types of poison pills”.

Broker Non-Votes: Most shares of most funds are held for the shareholders at brokerage firms in “street name” – meaning that the legal registration of the shares is in the brokerage firm’s name rather than the individual’s name. Brokerage firms inform shareholders of elections and solicit their voting instructions. When shareholders do not provide voting instructions the brokerage firm may or may not have the right to vote the shares for those shareholders. This author believes that brokerage firms and other financial institutions typically have an incentive to acquiesce to the preferences of fund managers rather than offend them (and potentially losing brokerage accounts or other business dealings with the fund) by voting in favor of activism.

The DoddFrank Act often prohibits firms from voting these shares unless they have received instructions from the clients. When neither the shareholder or brokerage firm provide voting instructions the shares are counted in a category knows as “broker non-votes” and therefore do not count as being for or against various proposals.

However, the fund industry succeeded in preventing fund shareholders from protections: “Beginning in 2010, uncontested director elections will be considered “non-routine” matters (except in the case of investment companies registered under the Investment Company 1940 Act that were specifically excluded by the amendments), and brokers will be prohibited from voting uninstructed shares” see [see Endnote 8]. Although BDCs claim this special treatment, BDCs may not technically be registered under the ’40 act [see Endnote 9 which asserts that BDCs are organized under the SEC Act of 1933] but elects to be subject to the regulations of the ’40 Act. Thus it is debatable whether the exceptions allowed regarding broker non-votes for ’40 Act funds are available to BDCs.

Here’s the bottom line, broker non-votes tend to be cast in favor of existing fund managers in so-called “routine matters” such as uncontested elections of Directors and ratification of auditors. In this author’s opinion these special protections offered to fund managers form uphill battles that can allow egregious expropriation of shareholder wealth from shareholders to managers such as those detailed in the next section.

WARNING #2 ON BDC INVESTING: BEWARE INCENTIVE FEES ON “N.I.I.”

What this section reveals will shock even the most cynical investors. Understanding the full depth of the enormous problems with some BDCs requires understanding the role of incentive fees. This is facilitated by viewing incentive fees as call options and is detailed in the next few subsections. The first few subsections describe fee computations for traditional private funds such as private equity funds, hedge funds and private real estate funds because the fees of many listed BDCs follow a similar structure.

Incentive fees as a call option

Incentive fees as found in typical private funds offer investment managers a share (e.g., often up to 20%) of profits. In the case of traditional private equity funds, the fund’s life is limited to a terms of perhaps 10-12 years. The incentive fees received by managers can be viewed as a call option on the fund’s final value with a strike price equal to the fund’s original investment. Accordingly, managers receive 20% of the profits despite having invested relatively little in the fund compared to the outside investors (e.g., limited partners).

In some private funds such as real estate funds there may be a “hurdle rate” that the limited partners must receive before the managers receive incentive fees. For example, a hurdle rate of 7% would require that investors receive a 7% annual accounting-based return before managers collect incentive fees. The hurdle rate can be viewed as increasing the strike price of the “incentive fee call option”.

Fund incentive fees “as a whole” or “deal by deal”

A problem that arose with some private funds is that funds were organized to favor the managers by specifying that incentive fees would be determined on a “deal by deal” basis rather than on the “fund as a whole”.

To illustrate, consider a fund with thirty deals of equal sizes. Twenty deals generated large profits and ten deals generated large losses. In a “fund as a whole” computation of incentive fees the ten losses would be netted from the twenty profits (prior to consideration of any hurdle rates) and the managers would receive incentive fees only on the net profit.

However, on a deal-by-deal basis with thirty deals of equal sizes (continuing with twenty deals generating large profits and ten deals generating large losses), the ten losses would not be netted from the twenty profits and therefore the managers would receive incentive fees on the twenty profitable deals with no offset for losses.

Deal-by-deal incentive fees rightfully came under attack, not only because they often generated enormous incentive fees on funds with little or no net profitability, but also because they incentivized managers to take especially large risks in search of highly profitable deals.

Basic option theory provides clarity. Incentive fees on a “funds-as-a-whole” basis can be likened to owning a single call option on a portfolio of assets. Incentive fees on a “deal-by-deal” basis can be likened to owning call options on each asset within the portfolio.

It is an axiom of option theory that a options on an index such as the S&P 500 is less valuable than a portfolio of options on the individual assets that comprise the index. This axiom has special importance for the incentive fee structures of some BDCs that base incentive fees on net investment income (as detailed next).

BDC incentive fees on Net Investment Income (N.I.I. or NII)

In the case of accounting for BDCs, net investment income is usually defined as summing all investment income other than capital gains/losses and netting out certain investment-related expenses such as interest expense on leverage and certain other expenses such as amortization of deferred financing fees and general and administrative expenses. For details see BDC Review’s Net Investment Income Overview [Endnote10].

“Bifurcated Incentive Fees”

In the case of funds investing in bonds, the issue becomes especially important as to whether incentive fees care be calculated on: (1) the combined sum of interest income and capital gains, or (2) the bifurcated components of the coupon income and the capital gains and losses.

When separate incentive fees are computed on the separate components (income and capital gains), the managers hold two call options. As discussed previously in this article, individual call options on two values are more valuable than a call option on the sum of the values.

However, far more important than having two call options occurs when managers are able to transfer gains and losses between the two underlying values (income and capital gains). As discussed in the next section the option on net interest income can be driven to a high value by purchasing bonds with very high coupons. The likely capital losses on defaults cause minimal losses in incentive fees on capital gains because the managers hold long call positions that offer asymmetric payoffs as detailed in the next section.

The Worst Part: Perverse Incentives

The worst part of these massive fees is that they incentivize managers to make decisions that depart ridiculously from what is best for shareholders. This powerful conflict of interest can lead to situations such as this:

Consider an unlevered fund with a 20% incentive fee and an 8% hurdle rate. The fund needs to decide between two portfolios (with no expenses other than incentive fees and with recovery rates set equal to zero for simplicity):

Portfolio #1: 8% coupons with 5% five-year cum. default rates (1% per year)

or

Portfolio #2 14% coupons with 35% five yr. cum. default rates (7% per year)

Note that Portfolio #1 might make sense because even with total losses of 1% each year the 8% coupons will leave a return before fees of 7%. Even a bifurcated incentive fee (which ignores the capital losses) would not generate an incentive fee on net investment income because the 8% income return does not exceed the hurdle rate. Management fees and fund expenses would likely still leave the shareholders with a positive return.

In the case of Portfolio #2 the 14% coupon income will be lowered with total losses due to defaults of 7% each year. Therefore the total return (before fees) would be only 7% – same as for Portfolio #1. But here’s the catch. Portfolio #2 can offer huge incentive fees to the manager if incentive fees are based on net investment income. In this case the 14% coupon income is 6% over the hurdle rate. The 7% return before fees (same as Portfolio #1) would leave the shareholders with a lower return that in the case of Portfolio #1 due to potentially large incentive fees.

With leverage included the incentive fees can be large. The net result is a perverse incentive that can lead managers to search for enormous coupon income even if it comes with anticipated defaults that will leave the shareholders with losses.

Further, leverage increases total assets and most fund managers are compensated with management fees based on total assets rather than net assets. This provides managers with a powerful and perverse incentive to borrow to levels that may be contrary to the best interests of the fund’s investors.

A highly levered fund with bifurcated fees can expose shareholders to massive losses while allowing managers to reap enormous incentive fees and management fees. Ka-ching!

Kicking Fees Up a Notch with Help from the Federal Government

A famous chef [see Endnote 11] likes to add spice to his recipes in order to take (or kick) it “up a notch”. Thanks to the cooperation of the U.S. Congress, BDCs have recently been allowed to use even more leverage than before. When this leverage is applied to bifurcated incentive fee arrangements and management fees on total assets rather than net assets, the resulting fees become truly astounding.

When a fund uses leverage of $2 assets to $1 of equity (i.e., Debt=equity) it doubles a 2% management fee without leverage to a 4% management fee on book equity. But wait – it gets worse. The exorbitant fees cause the fund’s market price to trade well below its book value. When the fees are expressed as a percentage of market equity value (as they are in the case of most equities and should be for all market-traded equities) the fees are even larger. A fund with a 2% management fee on total assets that is leveraged 2:1 (assets/equity) and is trading at a 50% discount (at the time of this writing ten BDCs had discounts greater than 50%) will have a management fee ratio of (wait for it…) 8%! Note that the 8% loss to the shareholders does not include incentive fees and expenses other than fees. Bam!

An Actual Example of BDC Fees

From a BDC’s recent filing with the SEC:

Management Fees: 4.05%

Incentive Fees: 2.18%

Total Advisory fees: 6.23%

Interest expense: 5.41%

Other expenses: 2.00%

Total on NAV: 13.64%

Implied total based on market price => 22.7%

The 22.7% figure is not taken from the filing but rather is based on an assumed 40% discount of market price to net asset value. Note that the expense ratios to the far right of Exhibit #1 (which are already absurd) are biased downward by being based on book asset values, not market values. Not only does this approach ignore leverage, it ignores overstated book values.

Could it be that these fees are reasonable if shareholders also receive great compensation? Perhaps, but the problem is that massive incentive fees can be and often is earned even when net asset value is declining and shareholders are losing money. This occurs when managers select high coupon investments (which tend to have high default rates). If the fund uses a “fund as a whole” concept any capital losses would offset the net investment income resulting in reduced incentive fees. But when fees are bifurcated (or based solely on net investment income), shareholders should better view the fund as being a “fund as a hole” to them.

Conclusions

Here are the key takeaways: Current and prospective BDC shareholders are well advised to dive deeply into understanding the potential fees in each BDC and to understand the perverse incentives that may result from those fees. The focus of this article is on describing: (1) some of the defenses that BDCs can use to fend off shareholder activists to retain their assets under management, and (2) potentially high fees from the use of bifurcated fee structures. However there are other reasons that BDCs with seemingly attractive dividend yields and heavily discounted market prices may be bad investments.

For example, the assets might be reported with dated or overly-optimistic valuations – making it difficult and risky for a shareholder to understand how much value truly underlies the BDCs portfolio of assets.

Successful BDC investing requires knowledge. A good place to develop a foundation of knowledge and experience is in listed closed-end funds which tend to have listed (i.e., exchange-traded) underlying assets and simple fee structures. Further, before delving into the “wild west” arena of BDCs, prospective investors should read extensive material about BDCs from diverse and reliable sources.

Passive investing can make sense in well-developed markets such as the U.S. market for large stocks. But neither passive nor active investing makes sense for inexperienced investors in BDCs. Passive BDC investing runs the risk that many of the constituents of BDC indices may be overpriced. Active investing runs the risk of consistently misunderstanding the complex issues involved in BDC valuation and consistently buying the BDCs that offer high yields but are overpriced.

In the near future I plan on writing articles on specific BDCs – one at a time – with insights into shareholder activism opportunities/threats, potentially perverse incentive schemes, valuation issues and the ultimate question: is there evidence that the portfolio manager is able to consistently select assets with attractive risk-adjusted returns.

ENDNOTES:

1. Investment Companies Advisor: The Gray Line between Level 2 and Level 3 Securities. See Investment Companies Advisor: The Gray Line between Level 2 and Level 3 Securities | Elliott Davis accessed September 2020.

2. See The BDC Universe taken September 4 2020.

3. Fair Valuation and Mutual Fund Directors: Alternative Approaches to Valuation. See Fair Valuation and Mutual Fund Directors: Alternative Approaches to Valuation | Perspectives | Reed Smith LLP, accessed September 2020.

4. See Lovell and Mahon, “BDC Fees and Structures Evolving” BDC Fees and Structures Evolving. The Hedge Fund Journal, April | May 2017, accessed September 2020.

5. For a summary of ways that Maryland law can protect fund managers over shareholders see Defending Maryland Closed-End Funds, by Scott Wilson of Miles & Stockbridge P.C. Defending Maryland Closed-End Funds | JD Supra accessed September 2020.

6. see Sullivan and Cromwell LLP 4/7/2010 accessed September 2020 at https://www.sullcrom.com/siteFiles/Publications/SC_Publication_Mutual_Fund_Advisory_Fees.pdf

7. see Defending Maryland Closed-End Funds, by Scott Wilson of Miles & Stockbridge P.C. Defending Maryland Closed-End Funds | JD Supra accessed September 2020.

8. seeSEC Approves Amendments to NYSE Rule 452 Eliminating Discretionary Voting by Brokers in Uncontested Director Elections by Vietti and Taylor at SEC Approves Amendments to NYSE Rule 452 Eliminating Discretionary Voting by Brokers in Uncontested Director Elections

9. See “Frequently Asked Questions About Business Development Companies” by Morrison and Foerster, accessed September 2020 at https://media2.mofo.com/documents/faq-business-development-companies.pdf

10. See Net Investment Income Overview accessed September 2020.

11. Borrowing a couple phrases from renowned Chef Emeril Lagasse.

The following partial screenshot may be viewed in place of the more comprehensive one above:

Disclosure: I am/we are long SVVC MCC PTMN GARS FDUS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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