BDCs: The Liquid Alternative to Private Credit
October 05, 2023
Read Time 3 MIN
In the ever-evolving financial landscape, investors are constantly seeking innovative ways to diversify their portfolios and achieve optimal returns. Over the last decade, private equity and credit strategies have surged in popularity due to their unique return and yield potential. However, these typically come with the trade-off of reduced liquidity due to lockup periods. Recently, though, capital fundraising for these private strategies has witnessed a decline. The importance of liquidity, especially in a market rife with uncertainties, is becoming more pronounced. In today's market where liquidity is highly prized, Business Development Companies (BDCs) present a compelling, liquid alternative to traditional private credit strategies.
Lack of Liquidity Impedes Private Capital Fundraising
Private credit and equity strategies have soared in popularity, offering attractive return and diversification opportunities. They have granted investors access to niche markets, which leads to distinct return profiles. Yet, recent data from PitchBook indicates a roughly 31% year-on-year decline in capital commitments to private strategies as of the end of June. One reason why investor appetite has waned for these strategies is their general lack of liquidity.
As geopolitical tensions, economic fluctuations and other macro factors introduce volatility and unpredictability into the financial landscape, the value of liquidity has skyrocketed. Investors, now more than ever, are prioritizing the ability to access and redeploy capital swiftly. This heightened emphasis on liquidity is leading many to reconsider the long lockup periods associated with private market strategies, resulting in a pivot towards more liquid investment vehicles, like BDCs, that can offer a similar exposure without liquidity constraints.
| Year-over-Year Fundraising Changes by Strategy as of 6/30/2023 | ||
| Strategy | Capital Raised ($B) | YoY Change |
| Private Equity | $454.6 | -16.6% |
| Venture Capital | $185.3 | -47.0% |
| Real Estate | $134.7 | -19.2% |
| Real Assets | $26.8 | -84.5% |
| Debt | $215.2 | -18.8% |
| Fund of Funds | $31.2 | -37.8% |
| Secondaries | $58.7 | 13.5% |
| Total Private Capital | $1,106.6 | -30.9% |
Source: PitchBook Data, Inc.; Q2 2023 Global Private Market Fundraising Report.
BDCs: The Liquid Alternative to Private Credit
Business Development Companies are publicly traded entities focused on lending to and investing in private businesses. Established to promote investment in small and mid-sized firms, BDCs open doors to private credit markets. A standout advantage of BDCs is their inherent liquidity. Unlike traditional private credit funds, which often have multi-year lockup periods, BDCs are listed on major stock exchanges and can be traded daily. This grants investors the ability to modify their positions in response to market changes, personal financial needs or altered investment tactics.
Although there is no true index for the entire private credit market, the Cliffwater Direct Lending Index, which tracks nearly $280 billion of private loans to small and midsize companies, can be used as a general proxy to understand how the performance of public BDCs compare. Looking at the below performance chart, BDCs have largely performed in line with the broad private direct lending market over the last 5 years. During this period, public BDCs have exhibited a high correlation, about 0.80, with the direct lending market. The most visible difference between the two return streams is the apparent lack of volatility of the private loan market. However, this is more a result of its low liquidity and lack of price discovery.
BDCs Perform in Line with Private Direct Lending Market | 3/31/2018 – 6/30/2023
Source: Bloomberg, Morningstar Direct. US Business Development Companies represented by the MVIS US Business Development Company Index. Private Credit Proxy Index represented by the Cliffwater Direct Lending Index.
In unstable market scenarios, the capacity for a swift exit or position reduction is invaluable. Private credit fund lockup periods can be both an asset and a liability. While they can insulate investors from short-term market fluctuations, they can also hinder capital access during extended downturns or unexpected liquidity requirements. Thus, an increasing number of investors are opting for BDCs as a more liquid alternative.
The Merits of a Diverse BDC Investment Strategy
There are many publicly traded BDCs available in the market today, each with distinct risk profiles based on their asset structures, sector and credit exposures, financing terms and management quality. Investing in individual BDCs demands rigorous research to fully understand each entity. A holistic market approach to BDC investment can offer industry-wide diversification, negating the need for granular BDC assessments.
The VanEck BDC Income ETF (BIZD) offers broad market exposure to publicly traded U.S. business development companies and may be appealing for those looking for a liquid alternative to private credit funds. BIZD seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the MVIS® US Business Development Companies Index, which tracks the overall performance of publicly traded business development companies.
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Important Disclosures
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.
An investor cannot invest directly in an index. Returns reflect past performance and do not guarantee future results. Results reflect the reinvestment of dividends and capital gains, if any. Certain indices may take into account withholding taxes. Index returns do not represent Fund returns. The Index does not charge management fees or brokerage expenses, nor does the Index lend securities, and no revenues from securities lending were added to the performance shown.
Business Development Companies (BDCs) generally invest in less mature U.S. private companies or thinly traded U.S. public companies which involve greater risk than well-established publicly-traded companies. While the BDCs that comprise the Index are expected to generate income in the form of dividends, certain BDCs during certain periods of time may not generate such income. The Fund will indirectly bear its proportionate share of any management fees and other operating expenses incurred by the BDCs and of any performance-based or incentive fees payable by the BDCs in which it invests, in addition to the expenses paid by the Fund. A BDC’s incentive fee may be very high, vary from year to year and be payable even if the value of the BDC’s portfolio declines in a given time period. Incentive fees may create an incentive for a BDC’s manager to make investments that are risky or more speculative than would be the case in the absence of such compensation arrangements, and may also encourage the BDC’s manager to use leverage to increase the return on the BDC’s investments. The use of leverage by BDCs magnifies gains and losses on amounts invested and increases the risks associated with investing in BDCs. A BDC may make investments with a larger amount of risk of volatility and loss of principal than other investment options and may also be highly speculative and aggressive. The Fund and its affiliates may not own in excess of 25% of a BDC's outstanding voting securities which may limit the Fund's ability to fully replicate its index. An investment in the Fund may be subject to risks which include, among others, investing in BDCs, investment restrictions, financial sector, small- and medium-capitalization companies, equity securities, market, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount and liquidity of fund shares, issuer-specific changes, and index-related concentration risks, all of which may adversely affect the fund. Small- and medium-capitalization companies may be subject to elevated risks.
MVIS® US Business Development Companies Index (MVBDCTRG) tracks the overall performance of publicly traded business development companies.
MVIS US Business Development Companies Index is the exclusive property of MarketVector Indexes GmbH (a wholly owned subsidiary of Van Eck Securities Corporation), which has contracted with Solactive AG to maintain and calculate the Index. Solactive AG uses its best efforts to ensure that the Index is calculated correctly. Irrespective of its obligations towards MarketVector Indexes GmbH, Solactive AG has no obligation to point out errors in the Index to third parties. The VanEck BDC Income ETF is not sponsored, endorsed, sold or promoted by MarketVector Indexes GmbH and MarketVector Indexes GmbH makes no representation regarding the advisability of investing in the Fund.
The Cliffwater Direct Lending Index (CDLI) seeks to measure the unlevered, gross of fee performance of U.S. middle market corporate loans, as represented by the asset-weighted performance of the underlying assets of Business Development Companies (BDCs), including both exchange-traded and unlisted BDCs, subject to certain eligibility requirements.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com/etfs. Please read the prospectus and summary prospectus carefully before investing.
© Van Eck Securities Corporation, Distributor, a wholly owned subsidiary of Van Eck Associates Corporation.
666 Third Avenue | New York, NY 10017
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Important Disclosures
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.
An investor cannot invest directly in an index. Returns reflect past performance and do not guarantee future results. Results reflect the reinvestment of dividends and capital gains, if any. Certain indices may take into account withholding taxes. Index returns do not represent Fund returns. The Index does not charge management fees or brokerage expenses, nor does the Index lend securities, and no revenues from securities lending were added to the performance shown.
Business Development Companies (BDCs) generally invest in less mature U.S. private companies or thinly traded U.S. public companies which involve greater risk than well-established publicly-traded companies. While the BDCs that comprise the Index are expected to generate income in the form of dividends, certain BDCs during certain periods of time may not generate such income. The Fund will indirectly bear its proportionate share of any management fees and other operating expenses incurred by the BDCs and of any performance-based or incentive fees payable by the BDCs in which it invests, in addition to the expenses paid by the Fund. A BDC’s incentive fee may be very high, vary from year to year and be payable even if the value of the BDC’s portfolio declines in a given time period. Incentive fees may create an incentive for a BDC’s manager to make investments that are risky or more speculative than would be the case in the absence of such compensation arrangements, and may also encourage the BDC’s manager to use leverage to increase the return on the BDC’s investments. The use of leverage by BDCs magnifies gains and losses on amounts invested and increases the risks associated with investing in BDCs. A BDC may make investments with a larger amount of risk of volatility and loss of principal than other investment options and may also be highly speculative and aggressive. The Fund and its affiliates may not own in excess of 25% of a BDC's outstanding voting securities which may limit the Fund's ability to fully replicate its index. An investment in the Fund may be subject to risks which include, among others, investing in BDCs, investment restrictions, financial sector, small- and medium-capitalization companies, equity securities, market, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount and liquidity of fund shares, issuer-specific changes, and index-related concentration risks, all of which may adversely affect the fund. Small- and medium-capitalization companies may be subject to elevated risks.
MVIS® US Business Development Companies Index (MVBDCTRG) tracks the overall performance of publicly traded business development companies.
MVIS US Business Development Companies Index is the exclusive property of MarketVector Indexes GmbH (a wholly owned subsidiary of Van Eck Securities Corporation), which has contracted with Solactive AG to maintain and calculate the Index. Solactive AG uses its best efforts to ensure that the Index is calculated correctly. Irrespective of its obligations towards MarketVector Indexes GmbH, Solactive AG has no obligation to point out errors in the Index to third parties. The VanEck BDC Income ETF is not sponsored, endorsed, sold or promoted by MarketVector Indexes GmbH and MarketVector Indexes GmbH makes no representation regarding the advisability of investing in the Fund.
The Cliffwater Direct Lending Index (CDLI) seeks to measure the unlevered, gross of fee performance of U.S. middle market corporate loans, as represented by the asset-weighted performance of the underlying assets of Business Development Companies (BDCs), including both exchange-traded and unlisted BDCs, subject to certain eligibility requirements.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com/etfs. Please read the prospectus and summary prospectus carefully before investing.
© Van Eck Securities Corporation, Distributor, a wholly owned subsidiary of Van Eck Associates Corporation.
666 Third Avenue | New York, NY 10017