Sales of nontraded business development companies are down sharply this year as advisers and their broker-dealers grapple with regulatory changes and uncertainty – the same forces that have also
severely dampened sales of nontraded real estate investment trusts.
Meanwhile, faltering performance at some nontraded BDCs has also worked to dampen financial advisers' enthusiasm for the products, according to industry executives.
With just two months to go, BDC sponsors have raised just $1.26 billion in 2016 compared with $3.9 billion for the 12 months of 2015, according to Robert A. Stanger & Co. Inc., an investment bank. That translates into a stunning 61.3% year-over-year drop in nontraded BDC sales per month.
“Fund raising in this has been curtailed dramatically,” said Kevin Gannon, managing director at Stanger. “I think it is more performance driven than anything else. The weaker performance over the last year or two has had an impact on fundraising.”
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, nontraded BDCs are high-commission products sold to investors seeking yields to build an income stream and typically pay 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 that gives investors' greater clarity on the upfront loads of illiquid investments like nontraded BDCs.
The Department of Labor's new fiduciary rule, which is scheduled to take effect in April but may be delayed under a Trump administration, has also put a damper on sales of alternative investment products like BDCs.
“Capital raising is certainly down across the entire industry in 2016, driven primarily by regulatory uncertainty and, to a lesser extent, market volatility,” said Mike Gerber, executive vice president, administration & public affairs at
FS Investments, by far the largest nontraded BDC sponsor with $18.2 billion in assets under management.
FS Investments, formerly called Franklin Square, in 2009
successfully launched the first nontraded BDC, FS Investment Corp., which later listed on the NYSE. The success of that deal caused other product sponsors, many with experience in wholesaling nontraded REITs to independent broker-dealers, to team up with Wall Street credit managers and market new BDCs. Those two factors sent nontraded BDC sales soaring, hitting a peak of close to $5.5 billion in 2014 before this year's crash.
Some industry executives pointed to the decline in the net asset value of nontraded BDCs such as FS Energy & Power Fund as a reason for the slowdown in sales. The fund, which has $4 billion in total assets currently kicks off an annual yield of 8.6%. It launched at $10 per share in 2011 but was buzz- sawed in the sharp decline in energy prices during 2015, closing the year at $6.50. At the end of September, FS Energy & Power's NAV had climbed to $7.35.
“FS Energy and Power is one of the top selling products in the industry,” Mr. Gerber said. “Its performance since its inception has been strong, and its performance year-to-date has been strong. It has performed as designed, limiting volatility while providing downside protection.”
While the fund's NAV has decreased sharply over the past couple years, due to its growth and income the overall performance has remained positive. According to the company, the fund has generated a total return of 14.3% since its inception for advisers charging the full load. For advisers who have waived all fees and commission, as some RIAs will and instead charge a client a 1% annual fee based on assets under management, the total return was 27% since its 2011 launch, according to the company.
“Advisers wanting to help investors diversify portfolios by providing exposure to energy markets recognize that these markets are volatile and this fund has shielded investors from a certain amount of that volatility,” Mr. Gerber said.
Mr. Gannon noted that Wall Street powerhouses such as GSO/Blackstone, a sub-adviser of FS Investments funds, and KKR, which sub-advises CNL Financial Group BDCs, clearly command the attention of advisers looking under the hood at a nontraded BDC.
“These are enormous players,” he said. “If those guys could make it work, great, but there's certainly capital risk here to get those yields.”
“A default in credit is the No. 1 issue” about BDCs that should worry advisers, said Susan Kelly, director, investment management and research at Commonwealth Financial Network.
