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Guest post on “Business Development Companies”

TradingPub Admin | April 2, 2013

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Are BDC’s the new Buy and Hold?

Oftentimes as traders we are bombarded by offers of new and exciting ventures into instruments or companies that we have very limited experience with.  Such types of investments as MLP’s (Master Limited Partnerships) come to mind.  Recently I was hit by one of these types of investments called BDC’s (Business Development Companies).

BDC’s or Business Development Companies are firms that invest in other companies.  The firms that BDC’s invest in aren’t new nor do they provide seed money to an untested enterprise.  That falls under the domain of venture capital.  BDC’s do invest in firms that are currently operating and offer either a value proposition or a firm that is financially strapped but has proven itself in the past.

BDC’s were created by Congress in 1980 as an amendment to the Investment Company Act of 1940.  This is the same act that regulates Mutual Funds.  BDC’s operate in the same way as REIT (real estate investment trust) in that 90% (or more) of all proceeds must be returned to shareholders in the form of dividends.  This means that BDC’s pay little if any corporate tax as the shareholders themselves will be taxed upon the receipt of profits (dividends).

In recent years, the concept of buy and hold has been negated by scandals, malfeasance and the financial meltdown of 2008.  As any financial planner will tell you, stocks have always outperformed other forms of investments and if an investor just simply bought something and held onto it for 80 years, they would have netted a return of 26.8% in that same period of time.  Now I don’t know about you but I don’t have an 80 year time horizon and I don’t think anyone else does either.  As traders we like the idea of being in cash at the end of the day without concerns of malfeasance or other scandals.

However the question that comes to mind is are or could BDC’s be the buy and hold strategy of the 21st Century?  BDC’s are similar to Private Equity firms except that Private Equity (PE) is closed to the average investor.  That is pretty much the domain of the accredited investor.  An accredited investor is someone who has earned a net income of $200,000 per year without considering home equity or $300,000 if they are married.  They must show that they’ve earned this income for two consecutive years.  They are also subject to SEC rules when it comes to selling shares of a particular stock.  This is why you often hear of Board members of a firm having to publicly admit if they bought or sold shares of the firms that they have an interest in.  They do so because the SEC says they must.

BDC’s on the other hand are open to an investor and anyone who holds shares in a publicly traded BDC can buy and hold at will.  BDC’s also differ from private equity firms in that they don’t seem to specialize in Leveraged Buy Out’s (LBO).  Leveraged Buy Outs have become synonymous with hostile takeovers.  Most notably by KKR in the 1980’s with the RJR Nabisco deal.  This was the theme of the book and subsequent TV movie: Barbarians at the Gate.  So who are these firms?

This is a partial listing of BDC firms and they each have their own specialty in terms of what they invest and the amounts of capital they will invest.  Depending upon on who you listen to, these firms have a return of 5-12 percent annually.  But each investor must judge for themselves if this is suitable.  Remember that anything can happen in a volatile market.

Some of you may be asking isn’t Bain Capital a BDC?  Well, no Bain Capital is a Private Equity firm more in line with a KKR or Cerebus Capital Management.  Cerebus took part in Daimler Benz’s detachment from Chrysler Motors.  So are BDC’s the new buy and hold strategy?  Well possibly.  One thing is for certain if you were to compare these firms with REITs, you would have to admit REITs have done quite well.  Look at BPT (Prudhoe Bay Royalty Trust).  But then again, if the firm pays little or no tax it would be quite tough not to do well.

Lighthouse

Nick Mastrandrea is the author of Market Tea Leaves.  Market Tea Leaves is a free, daily newsletter that discuses and teaches market correlation.  Market Tea Leaves is published daily, pre-market in the United States and can be viewed at www.markettealeaves.com  Feel free to visit and subscribe.