BDC Stocks Soar by 12.8% in 2023, Despite Risks

Major investment firms such as Blackstone have pushed into business development companies, whose sizable yields are alluring.



Business development companies are having a good year, with the S&P BDC Index leaping 12.8% as of Monday’s close.

The increase marks a comeback for the asset class, which is one of the private credit fields that giant money managers such as Blackstone have entered. The BDC measure this year is far ahead of the investment-grade Bloomberg Global Aggregate Total Return Index (up 1.4%) and only slightly trails the Credit Suisse High-Yield Index (13.2%)—although none of the fixed-income indexes can compare to stocks, as seen by the S&P 500’s 17.7% advance in 2023.

“This is a compelling time to be investing” in BDCs, said Ron Kantowitz, head of private credit at asset manager Invesco, in a video clip posted on LinkedIn. While acknowledging that risks abound nowadays, he argued that careful due diligence will allow investors to pick the best ones and “invest away from” less-worthy BDCs.

BDCs—closed-end investment companies—are run to invest in small and medium-sized privately held businesses and offer lush annual dividend yields, which S&P Dow Jones Indices place at 10.2%, far above the S&P 500’s 1.5% and junk bonds’ 8.3%.

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As most BDCs use floating rates for the debt that dominates their portfolios, they have grown more and more attractive to yield-hungry investors. At this point, BDCs, along with other private debt offerings, have low default rates. As of year-end 2022, law firm Proskauer Rose, which specializes in legal advice to private credit, reported that the BDC sector had just a 1.04% default rate.

Public BDCs have ballooned, expanding to $200 billion in total assets in 2021 from $5 billion in 2002. Some big names, often affiliated with private equity titans, are in the publicly traded BDC space.

The leader in terms of assets is Ares Capital Corp. ($9.3 billion), followed by FS KKR Capital Corp. ($5 billion) and Owl Rock Capital ($4.8 billion). There also has been a surge in privately traded BDCs, with Blackstone Private Credit ($22 billion) in the lead.

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Private Credit: Fees Down, Rates Ascend

What Could Derail Private Credit’s Momentum?

Private Credit ‘at a Crossroads’ in 2023

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Insurance Executives Say ERISA PRT Rule Is Enough

Only minor changes to the DOL's PRT regulation, IB 95-1, would be needed to account for changing market conditions, industry leaders say.



Representatives of the life insurance and pension risk transfer industry say that only minimal changes, if that, are needed to the Department of Labor’s Interpretive Bulletin 95-1, that governs fiduciary standards for selecting an insurer for a pension annuitization.

The SECURE 2.0 Act of 2022 requires the Department of Labor to study IB 95-1 and report its findings and any recommended changes to Congress by the end of this year.

The DOL’s ERISA Advisory Council hosted a stakeholder hearing in July to discuss possible changes to IB 95-1. In a written submission to the council, Agilis, an insurance consultancy in the pension risk transfer market, explained that IB 95-1 is working well, but some positive changes could still be made.

The firm stated that an updated IB 95-1 should require fiduciaries to consider both the use of reinsurance and the cybersecurity administration of the provider. Michael Clark, a managing director and consulting actuary with Agilis says cybersecurity “should be explicitly mentioned in the standard.”

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Fiduciaries should also be made aware that they can use more than one independent expert when determining the safest annuity provider available, according to Agilis, and the DOL should make IB 95-1 a formal regulation, rather than an interpretive statement, so it has clearer legal force. Clark said the “DOL should issue formal regulations that codify IB 95-1.”

The Agilis statement also noted that some of the more common concerns about the PRT marketplace, as expressed at the hearing by advocates for labor and the elderly, are already addressed by IB 95-1. For example, the role of private equity investors as owners of insurance companies and that structure’s potential to create conflicts is addressed by the requirement to consider the insurer’s other liabilities or “lines of business.” Another concern, that insurers are adopting riskier investment portfolios, is also addressed already: “The quality and diversification of the annuity provider’s investment portfolio” is listed in IB 95-1, Clark said.

A written statement by retirement services and annuity provider Athene to the ERISA Advisory Council explained that part of the reason for moving to less liquid or riskier investments is because corporate bonds are more correlated and therefore less diversified than they have been in years past. This creates a need to diversify out of lower risk bonds.

Athene stated that “there is simply no compelling need to overhaul IB 95-1” because the legitimate concerns about PRTs are already addressed by IB 95-1 and no PRT payment has been missed because of a solvency issue since IB 95-1 was issued, a remark repeated by other representatives of the industry at the hearing.

Many labor advocates argued at July’s hearing that annuitizing pension obligations removes Employee Retirement Income Security Act and Pension Benefit Guaranty Corporation protections from plan participants because life insurance companies are not backed by the PBGC or directly subject to ERISA.

Clark says it is “arguable that you are losing ERISA protections” because the provisions of the plan are transferred to the insurer and priced. The PRT product will normally mirror the benefits of the plan, and since that plan was designed under and subject to ERISA, the annuity is functionally the same.

Clark adds that the PBGC backup is not as great as some make it out to be. Pensions fail more frequently than insurance companies and the PBGC typically requires participants to take a “haircut”—sometimes a heavy one.

The PBGC does provide a guaranteed level of protection, and as an institution, is less likely to become insolvent than a life insurance company because it is backed by the federal government. This means that though participants may have to take a haircut if the PBGC takes over their pension, they are not facing the same risk they would be if their annuity manager becomes insolvent.

Clark concedes this point and says, “Both systems provide protection,” but adds that it is “hard to see a scenario where people lose as much as they might if the PBGC takes over their benefits” and that when it comes to a catastrophic failure of an annuity provider such that participants take a heavier hit than they would under the PBGC, “the likelihood of that isn’t zero, but it is pretty darn close to it.”

 

 

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