Historically, banks have played a large role in providing financing to firms for asset acquisitions, trade financing, growth strategies, etc. Following the global financial crisis, increasing global regulatory requirements (Dodd-Frank, Basel III, etc.) and a historically low interest rate environment have compressed profit margins, and dramatically altered the business model of banking.
In this environment, Business Development Companies (BDCs) and other non-traditional lenders are taking an increasing role in providing capital (typically on a floating rate, senior secured basis) to private middle market American companies. This has created new investment opportunities as well as risks.
Traditional banking products (checking accounts, savings accounts, and Certificates of Deposit) feature constant share prices, varying degrees of liquidity, relatively low interest rates, and FDIC insurance (up to regulatory limits) to protect depositors. Investors can also purchase the stock or bonds of these institutions, which carry varying degrees of risk and return potential.
Investors in business development companies and other emerging lenders can either invest in the equity of the firms or in the bonds issued by such firms (and, in the case of online peer-to-peer lending, directly in certain lending transactions). Due to the regulations governing BDCs as pass-thru entities, BDCs tend to offer higher monthly distributions to equity owners than is usually offered by banks, but this also limits the amount of retained capital such firms can use to grow their businesses. As equity (whether listed and traded on a stock exchange or non-traded) it is not subject to FDIC insurance and share prices can be volatile. In general, equity prices fluctuate with the performance of the firm’s loan portfolio, the firm’s earnings, and overall stock market and economic conditions. Similarly, BDC bonds share many risk/return characteristics with other traditional fixed rate securities. Some investment vehicles are more liquid than others.
The cost structure, liquidity, strategies, terms and features of closed end investment offerings (typically, non-traded equity) are governed by prospectus. Risk and return potential vary by sponsor, offering, and overall market and economic conditions. Past performance is no guarantee of future returns.
Alternative investments are more complex than traditional investment vehicles and can have different fees and cost structures. They often invest in illiquid assets, which can make them difficult to exit and price on a regular basis. Some strategies involve leverage which can magnify gains or losses.
BDCs and other non-traditional lenders may provide relatively high income with a low correlation to traditional fixed rate debt and may provide useful diversification in client portfolios.
A trusted advisor, acting in a fiduciary capacity, is an essential business partner who can help determine the mix of investments that may be right for you.