Advisor & private credit manager weigh in on outlooks for this challenged asset class
Each month at WP we take a deep dive into a topic highly relevant to Canadian financial advisors. This April we’re focusing on fixed income.
BDCs are down. Business Development Corporations, which lend to private small and mid-sized companies, have been a longstanding means of accessing the dynamics in private credit lending from a retail investment account. That has been particularly true of publicly listed BDCs, which come with intraday liquidity and the transparency that many retail investors need. However, volatility in the space and investor reticence around BDCs has resulted in poor NAV performance. The S&P BDC index, which tracks leading BDCs trading on US exchanges, is down almost 13 per cent year to date.
Despite, or in some ways because of, that poor price performance, Francis Sabourin is advocating for these investments. The Senior Investment Advisor and Senior portfolio manager at Francis Sabourin Wealth Management of Richardson Wealth says that investors who can look through price volatility can pick up double-digit yields from publicly listed BDCs. It’s a view that he articulated in January and despite significant price declines, he’s doubling down on that belief in April.
“Things got a little bit more volatile as we expected. We say you need to live with the volatility of publicly listed BDCs,” Sabourin answers, when asked how the market has changed since January. “Right now there’s a great opportunities if you just buy a little bit, dip your toe in the water and clip your coupons monthly and then then the sun will come back.”
Sabourin notes that BDCs have faced something of a “perfect storm” this year as investors assume AI disruption of software as a service (SaaS) companies. Many smaller SaaS companies are backed by loans from BDCs, and some investors are reacting negatively to those loans. Moreover, Sabourin argues that public BDCs have tended to be more popular among retail investors, and that group’s inherent lack of patience has resulted in some volatility that might not come with larger institutional investors.
That downturn is, in Sabourin’s view, a buying opportunity. Yield is a huge component of that view. MVIS US Business Development Companies Index, had a 12 month yield of 13.96 per cent as of April 10th. He believes that these BDCs won’t go bankrupt over their SaaS loans, and that public BDCs are currently offering a better price and a higher yield than their privately-listed equivalents. While there is a negative feedback loop of news and selling pressure keeping BDCs down for now, Sabourin believes that when it does end, buyers at the low end will be rewarded both by their yield and by eventual NAV appreciation.
“That sounds like a smart advisor,” says Jurgen van Vuuren, Senior Director & Head of Private Debt at Nicola Wealth, in assessing Sabourin’s view of the BDC market. “If you’re really on top of it and you can buy at a significant discount to NAV and then you can exit at a premium to NAV and then maybe wait until the trade because they go up and down. It’s a bit more of an active trade, which I think for most advisors and most high net worth clients is probably a little bit much to ask. But in a time like this where I do think we’re in a bit of a dislocation, where the market seems totally irrational on the valuations of these things and you’ve got them trading at huge discounts to NAV, I think it’s a pretty interesting trade.”
Van Vuuren notes that his fund at Nicola has used BDCs in the past, with a preference for the larger and more established names on the market. His team will usually add exposure to BDCs when they hit specific valuation levels. He notes that we’re still not quite at a level where his team would enter the market, but he say’s “we’re getting close.”
Expectation setting is essential with BDCs and van Vuuren believes that advisors and investors should be looking at these products for premium yield. Yields should be higher than what’s available in high yield or leveraged loan ETFs to account for the amount of volatility that a BDC exposure will add to a portfolio. Like Sabourin, van Vuuren believes that there is currently a lot of noise contributing to contemporary volatility in BDCs. He recommends managing long-term risks by looking for larger BDC managers with established track records.
Sabourin likens the opportunity in contemporary public BDCs to the preferred share market in March of 2020.
“Four months after I made those purchases I was proven right. I paid $18, they went up to $25 and the preferred share market has been rolling on since then,” Sabourin says. “To me, there’s a dislocation [in BDCs] and you might be in the eye of the storm, but there will be value there.”
