Research. Research. Research.
FIRST LOOKS CAN BE DECEIVING: One of the key lessons we’ve learned from investing in Business Development Companies for over a decade is that what you don’t know can hurt you. Just being familiar with a BDC’s latest earnings release is not enough.In fact, the quarterly numbers can actually mislead. We remember how BDC earnings peaked in the first half of 2018. Those numbers were artificially boosted by the huge fees BDCs were charging a record number of their borrowers for one-time amendments. A few months later, many of those same borrowers were in default or in bankruptcy. The very item that seemed to suggest BDCs were doing very well was a leading indicator of doom. Yet, investors who were familiar with the 23 public BDCs in the market at the time and who de-constructed the composition of the earnings could work out what was going on, even if they might not guess what would happen next.
DELUGE : Admittedly, there’s so much to know where BDCs are concerned, not to mention that the number of public entities has doubled since the end of 2007 ! Besides the earnings releases, there are the company presentations; the Conference Call transcripts; the quarterly and annual financial results; the “shelf filings” ; the daily updates on insider transactions at one fund or another; the annual Proxy Filings and on and on.
COVERING THE WATERFRONT: Nonetheless, we decided a couple of years ago that we were not going to be satisfied just reading SOME of the torrent of information, and committed ourselves to reading EVERYTHING. Research for us means gathering up every day every new publicly information item we can find about every publicly traded BDC, then reading and annotating as we deem appropriate. We use data aggregation tools from Alpha-Sense and Advantage Data to speed the process. Our “research driven” approach keeps us up to date with most all the small and large changes going on at every BDC, and provides plenty of fuel for our analytical fires. To get an inkling of the amount of research we undertake, please read the BDC Reporter - our publication - and our News Of The Day feature..
OUR CONTROVERSIAL VIEW : We’ve learned from adopting this approach that very little of value from an investment standpoint comes out of the quarterly earnings reports and the periodic press releases which most BDCs pump out throughout the year. These are mostly public relations exercises and often provide readers with an incomplete and unbalanced picture. We don’t blame the BDC Managers. Their fiduciary duty is to maintain investor confidence; seek to keep the stock price above book value in order to access the equity markets and assume that every earnings and credit challenge will be met without loss.
DEEP DIVING: However, to gain a more balanced investment picture we rely heavily on the official filings which every BDC supplies under the watchful eye of the SEC. In these documents , the issuing institution is held to a high standard of disclosure, and much is revealed which doesn’t get into the press release announcements and Conference Calls. Every quarterly and annual filing, and other types of disclosures besides, is a potential treasure trove to inform and guide. Here’s a brief and non comprehensive list: disputes with the regulators; “aggressive” or unusual accounting policies; tensions with a fund’s lenders; insights into variances between GAAP and Tax income; problems at subsidiaries; insider ownership trends, etc. Some other investors read all the above as well, but many do not have the time or inclination to spend the several hours a day of every day (week-ends included) to remain current with What’s Happening in the BDC sector. We do.
BREAKDOWN: We’ve gone even further with our research. We target the quarterly portfolio updates that each BDC is required to provide about the composition, value and terms of every investment on its books to assess what the future might hold for book value and earnings. We break these portfolios down to the “granular” level, looking at each investment in turn. We use both the BDC’s own valuations - and the trends therein - as well as whatever public information we can scrape together to project which investments are likely to perform to plan and which may not. After all, at the core of BDC investing is credit underwriting. Our investment-by-investment research is intended to provide us with as objective a sense of the odds of success as possible.
RESEARCH WITH A CAPITAL R: Our ambition is to develop a continuously updated database on all 5,000 or so companies which BDCs lend and invest in. To date, we’ve focused on the underperforming companies in the BDC universe, and have identified over 500 already from the pages of the periodic filings.. We’ve set up daily search updates for each name, and we’re on our way to knowing - almost in real time - whatever is happening for good or ill to every “troubled” portfolio company out there. With that information in hand - albeit frustratingly patchy - we have a clear eyed and independent view of what’s going right, but also wants going or might be about to go wrong.
ONE FINAL STEP : Of course, there’s much we cannot know, and some of the information confuses and contradicts. What’s more, research can only take any investor so far. At the end of the day - we and you and everyone else - has to make the right investment choices from what we know. Nonetheless, in the world of BDC investing - and in much else besides - forewarned is forearmed.