Additionally, typical private investment funds distribute their returns to investors near to, or at the end of, their lives, while BDCs strive to provide a steady stream of income. Their mezzanine investments generate cash via the interest paid by borrowers, and the tax code requires BDCs to pay out at least 90 percent of that income to shareholders, which they typically do in the form of quarterly dividends.

However, we should weigh these advantages against some significant drawbacks. First, when they debut, the funds must pay fees to the underwriter of their initial public offering. If the investment bank that takes one public charges a 5 percent fee, it reduces the investable assets of the BDC by that amount.

TOP VIEW Private equity returns combined with stock market liquidity and ease of access sounds like an unbeatable mix. Over a dozen leading private equity firms announced plans in the last year to offer this attractive amalgam through a vehicle called a business development corporation (BDC), which raises capital on the stock market. However, these investments suffer from high fees, often-inefficient use of capital and poor aftermarket performance. Investors have stayed away in droves, causing many of the sponsors to shelve their offerings. Even so, some BDCs could emerge as attractive investments if the right set of market circumstances prevail.

A second drawback is a result of the BDC policy of raising money far in advance of investing it. With a typical private equity fund, we commit to providing our capital in stages, as the fund is able to put it to work, and we may invest it in productive ways until that time. However, if we invest in a BDC at its initial public offering, we pay all our money up front, meaning it may sit in low-yielding assets for as long as a few years, until the fund finds enough attractive investments. In the meantime, we sacrifice the additional yield we might have obtained on the money, had it been left in our hands; meanwhile, our investment in the BDC will most likely underperform until the firm has invested its capital.

Ongoing fees are another concern. BDCs start charging fees from the get-go, despite the fact that they have not yet invested their capital. There is often a front-end load taken directly out of the IPO proceeds—Apollo’s was 6.25 percent. BDCs also charge a 2 percent annual management fee. While this is typical of private equity funds, it is aggressive for funds aimed at retail investors. Like traditional private equity funds, the BDCs charge 20 percent of returns as an incentive fee.

Also, while a highly liquid security providing access to a diversified portfolio sounds attractive, it is not the whole story. Thomas Herzfeld, a Miami-based investment advisor who specializes in closed-end funds, warns, “Returns for BDCs tend to be less predictable than for closed-end funds with more actively traded portfolios.” As a result, he says, “Their behavior is more erratic than the stock market in general,” so timing our sale of these funds to get out with a gain can be difficult.