I’m excited to share my interview with Nicholas Marshi, an expert on the BDC sector who has been investing in the space for the last twenty years.
No one knows BDCs better than Nick, and I’m a happy subscriber to his various BDC publications. If you invest in BDCs, this interview is for you.
Nicholas Marshi is the Chief Investment Officer of BDC Investment Advisors and publisher of three specialized BDC publications.
His insights offer valuable lessons for both professional and individual investors looking to understand this distinctive asset class.
Table of Contents
Key Takeaways From the Interview
Here are some of the key takeaways.
Specialization and Deep Knowledge
Marshi’s journey began when he successfully sold a company from his private equity fund and chose to manage the proceeds himself rather than hand them to a money manager.
His background in lending and private equity gave him confidence that he could succeed in the BDC space. “I felt that given my background in lending and private equity, I had a better chance of investing success than in most anything else out there.”
Thorough Research Is Non-Negotiable
“I am an insecure investor. I always want to know as much as possible about the BDCs I might or might not invest in.”
Marshi reads every filing, press release, and conference call transcript for the 46 public BDCs he follows.
He builds comprehensive data tables and familiarizes himself with individual portfolios, identifying the roughly 150 companies out of 7,000 BDC-financed companies that are large enough and troubled enough to materially impact BDC performance.
BDCs Are More Complex
“BDCs are not just lenders. They are also minority equity investors in the companies they lend to, and when needed, they can become turnaround specialists. At times, they even command and control portfolio companies.”
This complexity means investors need to look beyond simple credit results when evaluating BDCs.
Not All BDCs Are Created Equal
There are huge variations in BDC performance because they operate in five distinctly different segments of the non-investment grade market, each with very different economics, risks, and competitors.
“You really can’t compare a venture-debt BDC, principally lending to start-ups with no profit history, with a BDC serving borrowers in the upper middle market involved with billion dollar-loans.”
Patience and Nerves of Steel
BDC investing requires both patience and strong nerves.
“Having and holding and re-investing those monthly or quarterly payouts is what generates superior returns. Patience is very important in BDC investing – a quality many investors lack, including myself at times.”
The sector can be highly volatile – during the GFC, Ares Capital dropped 87%, and in March 2020, the sector dropped more than 50% in one month.
Outperformance Is Possible
While BDCs are “handcuffed by their format” with earnings that must be paid out rather than retained and limited leverage, real outperformance is still achievable.
Over the last 5 years, when the S&P 500 climbed 96%, 27 of 37 BDCs performed better – some by as much as three times.
Over 10 years, 9 of 32 BDCs outperformed the S&P’s remarkable 215% total return.
Structure Provides Downside Protection
The BDC format makes it difficult for investors to lose too much money with a buy-and-hold approach.
Over the last 5 years, not one BDC ended up in the red, and over 10 years, only 4 out of 32 BDCs were losers.
However, this protection disappears for investors who “flit from BDC to BDC.”
Missing the Bigger Picture
“Ironically, investors who see BDCs just as vehicles to harvest dividends and fail to reinvest are missing out on the power of compounding.”
Those treating BDCs as bond proxies, expecting safe, steady dividends are often disappointed, as dividends fluctuate with interest rates, credit losses, and payout strategies.
Quality Management Teams
While Marshi wouldn’t speak ill of any management team, he highlighted three organizations he particularly admires: Ares Capital (the biggest and one of the oldest), Saratoga Investment (which rescued a near-bankrupt BDC and transformed it), and Barings BDC (which built a diversified portfolio from scratch).
He notes it may not be coincidental that the BDCs he admires most are the ones that have performed best for him.
Market Conditions Require Caution
“Right now, BDC prices are just recovering from Liberation Day, and many are trading at healthy discounts to their price just 3 months ago.”
However, with recession predictions and concerns about credit investments, Marshi emphasizes it’s “a time to be more careful than usual,” though he remains optimistic about select opportunities in the space.
Conclusion
Nicholas Marshi’s approach to BDC investing demonstrates that success in specialized markets comes from deep knowledge, thorough research, and the discipline to stick with quality investments through volatile periods.
His insights reveal that while BDCs may not offer the explosive returns of venture capital, they can provide attractive risk-adjusted returns for investors willing to do their homework and maintain a long-term perspective.
For those considering BDC investments, Marshi’s emphasis on understanding the complexity of these vehicles and the importance of selecting quality management teams provides a valuable framework for evaluation.