Why Kenya’s capital market needs high yield risk funds

Kenya’s capital market needs high yield risk funds. FILE PHOTO | NMG 

By RUFUS MWANYASI
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Summary

• A BDC is a like a money market fund (but a closed-end fund [CEFs]) that provides private firms with debt and equity capital, or a combination of the two, to help them grow.
• The structure came into existence after the US Congress passed an amendment to the Investment Act of 1940 in 1980 (although most CEFs proliferated in the 2000s).
• Essentially, income investors that buy into BDCs are looking for high yields from dividends and interest payouts.

Consider this to be a follow-up article to the one published on December 10, 2019, titled “Investment firms care more about their wins than yours”.

While the substance of the previous article dwelt on the risks money market funds could possibly be undertaking in the race to post higher yields and, by extension, gather more assets, today’s article is a suggestion to a different kind of fund.

A new fund structure specifically built to satisfy the appetite of yield-chasing investors. A yield fund built for a “laissez-faire” approach to risk.

One licensed to “fish for yield” where money market funds cannot. I am referring to the “newest” fund structure in the market: Business Development Corporation (BDC).

For starters, a BDC is a like a money market fund (but a closed-end fund [CEFs]) that provides private firms with debt and equity capital, or a combination of the two, to help them grow. The structure came into existence after the US Congress passed an amendment to the Investment Act of 1940 in 1980 (although most CEFs proliferated in the 2000s).

Essentially, income investors that buy into BDCs are looking for high yields from dividends and interest payouts.

This is made possible since BDCs being listed entities, and just like real estate investment trusts, are legally required, in exchange for a favourable tax treatment, to distribute at least 90 percent of their income to unit holders every year.

The 41 listed BDCs share a combined total market capitalisation of Sh8.9 trillion.

To our question; why is a BDC a necessary addition to our capital markets?

One, compared to money market funds, BDCs, owing to their natural mandate to seek for higher yields, can easily navigate the world of risky ventures without violating a restrictive statutory investment criterion. According to data from Closed End Fund Advisors (CEFA), the average market yield on the universe of BDCs that is currently paying a dividend, as of September 30, 2019, is about nine percent with the highest yielding BDC standing at 14.8 percent. Two, being listed vehicles, BDCs offer retail investors more options beyond the traditional fixed income investments and money market funds.

Over the past decade, BDCs have boosted yields earned by income portfolios thanks to their outsize distributions. Three, BDCs can help mobilise savings.

On the flip side, the many small and medium sized companies in the country get to have an alternative funding source. In all, these companies can help fill the void that exists in the financing market place.

Of course, this product type is not immune from the usual investment risks, it’s, nonetheless, a necessary addition.

Needless to say, with BDCs, fund sponsors can rest easy without having to push the “yield-pedal” via money market funds as these funds step in to satisfy the appetite for higher yields.

Mwanyasi is MD, Canaan Capital Ltd