Exchange traded funds that cover small-capitalization equities may include exposure to business development companies. However, investors should not be intimidated by the higher “prospectus expense ratio.”
According to Securities and Exchange Commission regulatory rules, funds are required to include in their prospectus expense ratio the pro-rata – a fraction every shareholder is assigned equal to the proportion for each share he or she owns – share of any expenses from investments in other funds, writes Michael Rawson for Morningstar.
Essentially, an ETF comprised of other funds has to list the expense ratio of the underlying funds, along with the management fee tacked onto the ETF itself.
Business development companies invest in private companies or thinly traded public companies and are registered as a type of closed-end funds. Additionally, BDCs also provide some direct managerial advice or direction in selecting investment opportunities.
Since BDCs are a type of fund, any ETF that holds BDCs will be required to list the BDCs’ managerial expenses, or “acquired fund expenses,” along with the ETF’s expense ratio as the net expense ratio.