Sales of nontraded business development companies are on track to decline for a third consecutive year and are on the way to posting their worst year for equity raising since 2010, when the product was just beginning to be widely sold by independent broker-dealers.
Nontraded BDCs managed to raise just $624 million over the first nine months of the year, compared to last year's 12-month sales total of $1.5 billion, according to Robert A. Stanger & Co. Inc., an investment bank that tracks the sales of alternative investments, including nontraded real estate investment trusts. And sales this year are far below the levels seen when the product was at its peak in 2014, when brokers sold $5.5 billion of nontraded BDCs, according to Stanger.
The product was first sold in 2009 and raised almost $100 million. A year later, sales totaled $369 million, according to Stanger.
Nontraded BDCs typically are closed-end investment companies that invest primarily in debt and equity of private companies. Yields can be attractive due to the BDCs' exposure to high credit risks amplified by leverage.
Like nontraded REITs, in the past nontraded BDCs were high-commission products sold to investors seeking yields to build an income stream and typically paid advisers a hefty upfront commission of 7%.
Similar to REIT sponsors, BDC managers have been adding alternative fund classes to decrease the upfront commission, shifting a percentage of sales commissions paid to advisers over time. Such changes in commissions make the product more palatable under new regulations, including a new industry pricing rule, known as 15-02, that gives investors greater clarity on the upfront loads of illiquid investments like nontraded BDCs.
And the Department of Labor's new fiduciary rule has also put a damper on sales of alternative investment products like BDCs. Sales of nontraded REITs are likewise poor and headed for their worst year since 2002, with the industry on track to raise just $4.4 billion in equity in 2017, about $100,000 less than a year earlier, according to Stanger.
Some BDC managers, including American Realty Capital and W.P. Carey, have exited the business, contributing to the decline in sales. And BDCs are typically restricted to selling only one share class per company, unlike REITs or mutual funds, executives said. That makes sales potentially more difficult as broker-dealers cut down the number of products with commissions on their platforms to comply with the DOL fiduciary rule.
"The reasons for the decline in BDC sales are the same as nontraded REITs," said Kevin Gannon, managing director at Stanger. "To some degree, it's regulation, 15-02 and the DOL fiduciary rule. Performance is also an issue. Some deals are heavily invested in energy transactions that did not fare well."
"In the wake of the DOL rule, and the continued uncertainty around it, it is becoming increasingly important for products to offer multiple share classes and BDCs are limited in their ability to do so," noted Mike Gerber, executive vice president, corporate affairs at FS Investments, the leading manager of nontraded BDCs.