Goldman Sachs' BDC launch signals high-yield investments on the rise

Financial advisers would be wise to bone up on the asset class because they'll be getting sales pitches

Mar 18, 2015 @ 9:06 am

By Jeff Benjamin

+ Zoom

Ready or not, financial advisers should start bracing for a fresh wave of business development company sales pitches.

The latest evidence of the push into the space is Goldman Sachs Group Inc.'s initial public offering of the Goldman Sachs BDC (GSBD), a closed-end business development company that started trading Wednesday. It will be the first BDC backed by an investment bank to go public in the U.S.

With an initial share price of $20, the offering is expected to raise about $120 million, and value the BDC at about $707 million, according to published reports. In mid-morning trading, the BDC was down 1.4% at $19.72.

Hot on the heels of Goldman Sachs, Credit Suisse Group has filed for an IPO of its Credit Suisse Park View BDC Inc.

Representatives from Goldman and Credit Suisse declined to comment for this story, but the movement into this relatively obscure BDC category is indicative of how the asset management industry in eyeing an opportunity to attract investors to the asset class.

SIGNIFICANT

“The Goldman offering is a significant continuation of a trend toward larger and more institutional managers becoming BDC managers,” said Todd Owens, co-president of Fifth Street Asset Management, which manages two public BDCs,

“It speaks to the growth of the BDC space,” he added. “I think you'll see across the entire BDC industry, players will get larger, more sophisticated, and more institutionally run.”

Fifth Street, which has $6 billion under management, runs two public BDCs, Fifth Street Finance Corp. (FSC) and Fifth Street Senior Floating Rate Corp. (FSFR).

BDCs, as they are commonly known, represent portfolios of high-yield private debt, which can be appealing in a low-interest-rate environment. Not only are yields hovering between 7% and 10%, but the floating nature of the bulk of the debt should make them even more attractive as interest rates rise.

But there are caveats.

For starters, BDCs come in two general flavors, including publicly traded and nontraded, and advisers need to know what they're getting their clients into.

In addition, the yields are high because the underlying portfolios are made up of below-investment-grade debt issued mostly to smaller private companies.

On the publicly traded side, the Goldman offering brings the total to 52 BDCs with a combined market capitalization of about $32 billion, which is part of the overall $1.8 trillion private debt market, according to a report by Cliffwater.

Publicly traded BDCs trade as stocks, which means plenty of liquidity. But because they trade throughout the day on exchanges, the share price is often out of sync with the net asset value of the underlying portfolio of private loans, which is why public BDCs tend to pay higher yields.

The nontraded space is smaller, representing only 13 BDCs that have a total of about $12 billion worth of investment capital. Liquidity is typically limited so investors can only request money back monthly or quarterly, which means yields tend to be lower. In addition, they are sold through brokers that often charge commissions of up to 10%.

But, according to Brian Mitts, chief operations officer at NexPoint Advisors, when comparing traded and nontraded BDCs, advisers should consider correlations.

“If you're buying a BDC, you're probably looking for non-correlated credit exposure, but a publicly traded BDC is going to trade more like a stock because it trades on an exchange,” he said. “Nontraded BDCs should have close to zero correlation to stocks.”

NexPoint, an affiliate of Highland Capital Management, which has $21 billion under management, kicked off a three-year capital-raising effort in September for its non-traded NexPoint Capital BDC, which currently has $17 million.

Mr. Mitts describes the Goldman BDC launch as a “bellwether move” that will help bring attention and add legitimacy to the space.

“Institutional players are looking at BDCs as an access point to the retail market,” he said. “Now that you've seen Goldman do it, I think you'll see others come in as well.”

BDCs have been gaining traction since the financial crisis, which effectively set the stage for alternative lending sources, according to Mr. Mitts.

“As we have seen increased regulations around banking and capital markets, it has made it harder for businesses to access public capital,” he said. “And that is forcing businesses into the shadow banking areas” such as BDCs.

Mr. Owens concurred, explaining that “banking regulators are limiting the scope of these kinds of loans at commercial banks, and that is creating opportunity for non-bank companies to step in and provide capital.”

BDCs, which are essentially portfolios of high-yield and mostly floating-rate loans, are expected to benefit from a rising rate environment.

“In a rising-rate environment, the yields on the underlying assets will increase,” Mr. Owens said. “That's positive exposure to rising rates.”

The impact of rising rates, however, will not likely show up until after a few rate-hike cycles.

BDC loan interest rates are pegged to the London Interbank Offered Rate, LIBOR, which is influenced by the Federal Reserve's interest rate policy, but set by banks. LIBOR is currently around 23 basis points. When the Fed raises rates, LIBOR will rise too. But the Fed will need to act several times before LIBOR moves above 1%, which is when BDC loans will start adjusting higher and investors will start earning more yield.

“In general, BDCs are pretty well positioned for rising rates,” Mr. Mitts said. “But you'd have to see an 80-basis point increase in LIBOR to have any effect on a portfolio.”

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