Last month, Ares Management Corp. made a big first step into the business development company (BDC) space with the launch of Ares Strategic Income Fund, a non-traded BDC. The fund reportedly launched with $1.5 billion in initial investible capital—and an eye on capturing a bigger piece of the growing market.
Ares is the latest entrant in what has become an expanding list of big-name sponsors moving into the BDC market within the last few years. Blackstone is once again blazing a trail that others have been quick to follow. Blackstone launched its private credit BDC (BCRED) in January 2021, and according to Bloomberg the fund raised $32 billion in its first year. Although Blackstone dominates capital raising with nearly half of the market share, the sponsor has been joined by Angelo Gordon, Apollo Global Management, Bain Capital, BlackRock, PGIM, HPS Investment Partners, Nuveen and Oak Hill.
BDCs are essentially investment vehicles that provide loans to high-growth companies across industries. Much like non-traded REITs and interval funds, BDCs are designed to provide retail investors with access to institutional quality private investment products. Funds also are finding ample opportunities to deploy capital in the current market. “It’s a great time for credit strategies with the credit retraction and retrenching occurring from a regional bank perspective,” says Anya Coverman, president and CEO of the Institute of Portfolio Alternatives (IPA).
BDCs are yield-oriented investments that typically generate annual returns between 7% and 10%, depending on the sponsor. They’re also required to distribute over 90% of their profits to their shareholders. “BDCs did get banged up a few years back because there were a lot of investments in energy companies, but more recently the returns have been good out of the bigger players,” says Kevin Gannon, chairman & CEO of Robert A. Stanger & Co., which tracks data for non-traded REITs, interval funds and BDCs.
BDCs are open to non-accredited investors with minimum investment amounts of $5,000. The main distribution channels are wirehouses and RIAs, and, to a lesser degree, independent broker-dealers. In addition, BDCs are often more attractive to investors in times of rising interest rates and inflation. “A lot of their investments are tied to floating interest rates, so as rates rise, the investments do a good job keeping up with inflation,” says Luke Schmidt, senior financial analyst at Blue Vault Partners, another firm that tracks the space. However, one downside risk is that during a recession, more of these investments are more likely to default, which can weigh on fund performance and result in poor returns.
“Capital raise and asset growth in the BDC space has exploded over the past two years. Blackstone has started to have a similar impact on the BDC industry as they did the (non-traded REIT) industry a couple of years ago,” Schmidt says. Prior to Blackstone's BDC, Owl Rock/Blue Owl was the only notable sponsor raising capital. Since Blackstone entered the space, there have been more than 10 other sponsors with new funds registered, with Owl Rock having two of them. In addition, there were sponsors actively raising capital as of the fourth quarter 2022 with several others in the registration process, adds Schmidt.
“It’s frothy out there in terms of the desire to enter this space, in large part because of the level of capital raised last year,” says Gannon. Across private real estate alts structures, non-traded REITs, BDCs, private placement products and interval funds, raised $100 billion last year, according to Stanger. And BDCs in particular raised a record high $23.9 billion, jumping from $14.3 billion in capital flows the prior year. “So, there is a lot of appetite by institutional asset managers who want to gain access to this channel,” adds Gannon.
Near-term headwinds
The growth trajectory for BDCs is bumping headlong into the same near-term market obstacles that are hampering fundraising across the broader investment universe. Stanger expects fundraising for BDCs to drop considerably lower this year to $10 billion. BDCs also have been hit with redemption requests similar to other real estate alts products, although not to the same level as what is occurring in the non-traded REIT sector. Redemption requests for BDCs totaled $2.4 billion last year, according to Stanger, and the firm is expecting that volume to double this year to roughly $5 billion. The redemption volume for first quarter across the 12 non-listed BDCs that Stanger tracks was at nearly $1.2 billion as compared to $4.6 billion for non-traded REITs.
The story unfolding in the BDC space is much the same as what is playing out in the non-traded REIT space. “Interest rates rose, so people expected price corrections from both non-traded REITs and BDCs,” says Gannon. That expectation has resulted in slower fundraising and accelerated redemption activity. “However, all of that is starting to dissipate, and I expect by the end of the year, we’ll be back to normal, meaning that fundraising will outpace redemption activity,” he adds.
BDCs are structured to handle liquidity requests with liquidity sleeves and caps on quarterly redemptions. Many of the underlying assets are short-term loans, which also makes it easier to generate liquidity, and they also can monetize those loans in the secondary market to generate needed liquidity. “The fundraising in the space is pretty healthy, and we think it is going to grow exponentially from here for a couple of reasons,” says Gannon. One, performance is likely to be good. And two, meeting the redemption requirements is demonstrating that these investments can provide a level of liquidity that retail investors demand. “Those two things are going to propel this industry forward,” he says.
New entrants see growth potential
Another similar theme to the non-traded space is the large institutional managers that are launching BDC investment products. Growth is due in part to large institutions looking to expand their menu of offerings across different categories, as well as product innovation in investment offerings across the private real estate alts market. Many of the players now active in the BDC space also are active with non-traded REITs, interval funds and/or private placements.
In 2020, the SEC allowed non-listed BDCs to issue multiple share classes, essentially giving them a very similar structure to the NAV REITs as a perpetual life vehicle. This is a pretty recent development, and the BDCs that have launched since then are all NAV BDCs. “We’re still at a relatively early stage of what we expect to see come into the market now that this willingness from the SEC to allow multiple share classes has been approved,” says Coverman.
Many of the institutional managers are responding to demand from investors and distribution channels—the wirehouses, RIAs and broker-dealers—for more investment choices. From a broader perspective, private equity credit strategies that provide access to retail investors is a growing area of the investment market. “The retail investor has never really had these opportunities to invest in the private equity space. So, a trend to watch is going to be the innovation and creativity in the private credit market, including BDCs and beyond,” she adds.