If you are at all a mutual fund investor, you have undoubtedly heard of Boston-based money manager Putnam Investments. The firm is one of the country's oldest mutual fund issuers, launched in 1937 by Mr. George Putnam. Putnam has seen its fair share of market cycles and had some of its own ups and downs over the years. It is currently responsible for approximately $169 billion of assets under management roughly split between retail mutual funds and institutional investors, and since May of 2021, about $122 million across six exchange traded funds. The firm's first four exchange-traded funds consist of three fairly vanilla growth products and one value fund that use some semi-transparent ETF technology licensed from cross-town rival Fidelity. In this article, though, I'm going to take a look at one of two new funds that stray a little outside of the style box and target-date fund products they tend to manage.
The Fund
The fund that caught my eye was the Putnam BDC Income ETF (PBDC) . I'll get into the expense ratio once I've explained what this fund is all about and you can get a better appreciation of why it's as high as it is.
Business Development Companies (BDC's) are a type of closed-end fund and would be best compared to a publicly traded tranche of an investment group's venture capital or private equity portfolio. Think of them as real estate investment trusts, but instead of property, they own some part of a private (or sometimes public) company, sometimes through an equity stake. Most of the time, BDCs are close to the top, if not at the top, of the capital structure as a first lien lender. This means they get paid back first in the event of any problems. To get a better sense of what a BDC holding looks like, I downloaded a recent investor presentation from one of PBDC's holdings, Sixth Street Specialty Lending (TSLX) .
Looking through the logos in the presentation, there are some familiar names, like iHeart Media (IHRT) , avidXchange (AVDX) , Biohaven Pharmaceuticals (BHVN) , and Neiman Marcus. Representative sectors include automotive, aerospace & defense, high tech and hotel, gaming, and leisure to name a few. The bulk of the investments in TSLX are loans, with 90.5% marked as first lien, 2.0% marked as second lien or subordinated debt, and 7.5% as equity investments. A total of 88% of investments are listed as having voting control, which from what I can, tell simply means that the BDC can vote on company matters in proportion to its ownership.
It should be noted that as BDC's are required to invest the bulk of their assets in private companies with valuations lower than $250 million, so it should not be surprising that BDCs generally carry a "BBB" credit rating. In other words, BDC credit quality is solidly "high yield," or "junk." From an income perspective, the fund does not disappoint. Per my calculations (portfolio weights as of Tuesday, crossed against the currently stated dividend yields of the holdings) this fund, had been open long enough to pay a full quarterly dividend would have a current yield of 11.52%.
Now that I've given you the good news, here's the bad news. While the management fee is only 75-basis points (bps), the issuer lists the acquired fund fees at -- are you sitting down? -- 9.86%, which translated into basis points is 986 basis points. Add that to the initial 75 bps and you have a total expense ratio of 1,601 bps, or 10.61% meaning that a shareholder with $1,000 invested over a calendar year would pay $106.10 in fees over that period.
My Take
At first blush, it seems like paying $10.61 to get $11.50 doesn't make a lot of sense. But BDCs give investors exposure to what for many is a new asset class, private equity.
Let's not forget that while some investors hope to change company management behavior by writing letters and voting shares, private equity firms are in the business of essentially buying companies, optimizing them, and then spinning them back out at significantly higher valuations. While we are at the early stages of a recession, there will be any number of businesses over the next 12 - 18 months that just might need some help, providing BDCs an opportunity to buy low then and sell high later, all while providing healthy distributions to shareholders. This is definitely a fund to put on your watchlist, and while you wait for the right entry point, give PBDC a closer look. Seriously, there are only 22 holdings and they are all publicly traded, so it shouldn't take too much time to review each holding and see what you would be getting yourself into.
