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Strategies & Market Trends : Value Investing -- Ignore unavailable to you. Want to Upgrade?

To: Sergio H who wrote (47850)	5/8/2012 10:47:26 PM
From: Spekulatius	2 Recommendations Read Replies (3) \| Respond to of 78667

The wikipedia article says very little about the risk inherent for BDC. 1) name me one BDC that does not use debt to enhance returns. As you mentioned before, BDC leverage is limited to 50% of the assets. if management is going close to the limit, breaching the limit means that a) Assets have to be sold (almost impossible because assets tend to illiquid) b) Capital has to be raised, often to very bad terms. Even if the loan limit is not breached, there is a risk that financing falls apart, which can result in a death spiral. The Ponzi scheme comes from various aspects. a) Management get's paid a fee, typically 2% of the assets. That incentives them to ramp up assets and leverage. b) High distributions are likely to attract investors reaching for yield, which push up the share price. This enables selling more shares, which increases management fees. This is the positive feedback loop that management tries to accomplish. The problem of course is that high yields can only be generated using the highest loan yields which almost certainly are the least creditworthy companies. it also encourages to use as much leverage as possible. c) management has a lot of leeway to value their assets. Because they are not liquid they are almost by definition Level 3 assets. Although, if a loan goes bad, there is a great incentive to roll it over with the company to avoid writeoffs. There is no FDIC looking over the shoulder like for banks that audits the results and sometimes catches shenanigans. I think potential investors should read Einhorns book about Allied Capital: amazon.com