BDCs are comprised of companies that fund small- to mid-sized private companies, which are usually rated below investment grade or not rated at all – these companies would find it harder to acquire traditional means of loans, so they turn to outside sources of capital. Since the financial crisis, regulators have clamped down on traditional lenders, making it harder for many businesses to access public capital.
Consequently, many of these private smaller businesses turned to loans from BDCs as an alternative. BDCs act as an alternative to bank loan debt, helping smaller companies grow and profiting off the investments, which in turn would then help investors gain exposure to the growth and income potential of these privately held companies. In an expanding economic environment, BDCs should also benefit from stronger domestic businesses.
Moreover, BDCs should also do relatively well in the kind of environment ahead where many expect an increase in interest rates. Since BDC loans are mostly floating rate, the companies could earn more as rates rise.
“A particularly pertinent feature of BDC portfolios today is that, on average, more than 70% of the loans made by BDCs include a floating rate feature,” Larson said. “These loans, in general, reset interest payments based on three-month LIBOR interest rate floors of 1%-1.25%. With three-month LIBOR currently over 1.1%, many BDCs’ loan portfolios may now benefit from the floating rate feature by adjusting their yields upwards should interest rates further increase.”
Investors who are looking for a high-yield, equity income position may consider BDC exposure to complement a traditional income-oriented portfolio.