Non-Traded BDCs

You can generally sell only when the fund offers to buy shares back, and the fund decides how much it will buy. Because the loans it holds do not trade on any market, the fund’s reported value is an estimate rather than a market price. Losing money in a non-traded BDC is not, by itself, a claim. The key questions are whether the fund fit the investor and whether the professional who recommended it fulfilled their duties.

This May Not Be Your Fault

If you were told a fund offered steady income from lending to private companies, and no one made clear you might be unable to get your money out, you are far from alone. These funds are hard to follow even for experienced investors.

That is why the professional who recommended one had a duty to understand it first, explain it in terms you could follow, and recommend it only if it fit you. Under Regulation Best Interest (Reg BI), a rule of the Securities and Exchange Commission (SEC), a broker must understand a recommendation’s risks, rewards, and costs, and have a reasonable basis to believe it is in the investor’s best interest. Meeting a fund’s income or net worth minimum is not the same as being a good fit: the Financial Industry Regulatory Authority (FINRA) has said in its guidance on complex products that qualification requirements do not replace a thorough, customer-specific suitability analysis. When that analysis is missing, the responsibility belongs with the broker and the firm.

How Non-Traded BDCs Work

The SEC’s investor bulletin on non-publicly traded BDCs describes a BDC as a way for retail investors to invest in small and medium-sized private companies. It is not registered as an investment company, but it elects to follow many protections of the Investment Company Act. At least 70 percent of its assets must go into certain types of investments, and the companies involved are often early-stage or financially distressed. Some BDCs focus on private credit, meaning loans made directly to businesses. Several features shape how a non-traded BDC behaves:

• Getting out depends on the fund. The SEC says investors generally can sell only when the BDC offers to repurchase shares, and that without a repurchase program they may wait several years for a liquidity event. A fund’s own filings say it is not obligated to make an offer in any quarter, only a limited number of shares are eligible, and if more shares are tendered than the limit, they may be accepted pro rata, meaning each investor receives part of what they asked for.
• The price is an estimate. Many of the loans do not trade, so a fund’s filings say they are valued at fair value, set by the fund’s adviser under the board’s oversight.
• Borrowed money is allowed. The SEC says a BDC may, under certain conditions, borrow up to two dollars for every dollar of investor money, which can magnify losses as well as income.
• Costs and distributions need a close look. The SEC lists up-front, management, and performance fees, and notes that a high-cost fund must perform better to produce the same return. A fund’s filings also say distributions may include a return of your own capital.
• You may invest before the fund owns anything. Some offerings are blind pools, meaning the investments have not yet been chosen.

Research published on the Harvard Law School Forum on Corporate Governance by a Harvard Law School fellow found that private BDCs sold only to wealthier investors reported substantially higher returns than non-traded BDCs sold more broadly. It also cautioned that stable reported values, which rest on estimates rather than market prices, offer no assurance that investors can cash out at those values. Some BDCs are instead listed on an exchange, where the price may be above or below the value of the fund’s holdings. This page covers the non-traded kind.

Example: a retiree who put a large part of their savings into a fund described as steady income may find, when they need cash, that they can sell only a portion of their shares in a given quarter, if the fund offers to buy any at all.

Common Examples of Non-Traded BDC Claims

• A fund presented as steady income or a bond substitute, with the limits on getting money out, the borrowing, and the risk to principal left unexplained — see Misrepresentation and Omission
• An illiquid fund recommended to a retiree or anyone who needed access to their savings — see Unsuitable Recommendations
• A large share of an account placed in one fund, or in several funds holding similar private loans — see Overconcentration
• A firm that approved the product for sale, or let concentrations build, without adequate review — see Failure to Supervise
• A fund recommended for the compensation it paid rather than because it served the investor’s needs — see Regulation Best Interest
• An older investor placed in a fund they could not leave during the years they most needed their savings — see Elder Financial Abuse
• Similar problems arise with other hard-to-sell products, such as non-traded REITs

How Can You Protect Yourself From Non-Traded BDC Losses?

Funds that are hard to sell call for more questions up front than a plain stock or bond does. A few steps that help:

• Ask how and when you can get your money out. Find out how often the fund offers to buy shares back, how much it can buy, and what happens if more people ask than it can take.
• Ask what the fund owns and how much it borrows. The SEC suggests asking how much debt the fund has taken on, and whether its loans are higher quality or lower rated.
• Ask about every cost. Ask for the up-front, management, and performance fees, and how they affect your return.
• Ask how the value is set. If the loans do not trade, who estimates their value, and how often?
• Check how much of your savings is going in. A small piece of a diversified account is very different from a large share of your retirement money.

Signs Your Non-Traded BDC May Have Been Unsuitable

• You asked to sell and were able to get only part of what you requested, or none of it
• You were told the fund was a safer alternative to stocks, or a substitute for bonds
• No one explained that the fund could limit how many shares it buys back
• You did not know the fund borrowed money
• The fund’s value looked steady for a long time and then dropped
• Your distributions were reduced or stopped
• You were told this was an opportunity once reserved for institutions or the wealthy
• A large part of your retirement savings went into this fund, or into several similar ones
• No one showed you what the fees were