Understanding Style Drift in Perpetual BDCs
The popularity of perpetual BDCs and speed of capital raise for some has made it harder for certain managers to selectively deploy capital into true middle market deals—leading to “style drift” that can expose investors to unwanted risks.
Private credit is becoming more accessible. Once squarely the domain of institutional investors, the asset class has seen its investor base expand significantly in recent years to include a growing number of wealth channel participants. This democratization of private credit has been enabled in large part by the emergence of investment fund structures like business development companies (BDCs). There are a few different types of BDC structures, and when determining how to access the market, investor preference around liquidity and stock price volatility play a significant role:
- Public BDCs are BDCs that trades on public stock exchanges. Public BDCs can offer investors meaningful liquidity, but they also come with a high level of investment volatility because publicly traded stocks move up or down with the markets.
- Private BDCs are another type of structure. Private BDCs resemble a drawdown structure where an investor makes a commitment, and that investment is drawn down like a private fund. This structure tends to offer lower investment volatility than a public BDC because it is not affected by the technical movement of the stock market. But, there is limited liquidity as investors have limited to no ability to sell shares.
- Perpetual BDCs are fund structures that allow investors to step into fully ramped and diversified portfolios with lower minimums, positioning them to earn quarterly (or monthly) cash dividends right away. Semi liquid perpetual BDCs, in particular, have become an increasingly popular way for wealth investors to access the market with the opportunity for quarterly liquidity via tender offer.
The increasing prevalence of perpetual BDCs in particular has been somewhat of a doubled-edged sword for some managers. On the one hand, they have allowed more investors to access the potentially attractive yields, historically strong risk-adjusted returns, and low relative volatility characteristic of private credit. But their growing popularity has also made it more challenging for some managers to generate a sufficient number of quality deals to satisfy demand—leading to a degree of “style drift” that can expose investors to unwanted risks.
