"Greed is a bottomless pit which exhausts the person in an endless effort to satisfy the need without ever reaching satisfaction." -- Erich Fromm
My team has now extracted incentive fee data for our BDC tool. The below charts show two key metrics – hurdle rate (minimum return before income incentive fees are earned) and the incentive fee percentage (the percentage fee earned on income beyond the hurdle rate).
My first observation is that the hurdle rate is absurdly low. The assets are deep junk rated loans (Single-B/CCC) and often include a high percentage leveraged equity positions. The average asset yield is 9-10%. Those risky assets are then 1x levered. So the natural yield after leverage, before debt costs is 20%. For a frame of reference, the ICE/BofA BBB index yields 5%.
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On what planet did BDC management decide that a 5% (or even 7%) hurdle rate was a reasonable place to start earning extra fees on top of the already generous base management fee?
Let's take a massively risky, illiquid portfolio,1x leverage it and then extract from investors an extra vigorish for the privilege of just earning more than they could earn on a liquid investment grade index. Sounds good to me.
The hurdle rate of 5-8% is particularly low considering that there is already a base management fee and that nearly all the BDCs include phantom pay-in-kind (PIK) income in the incentive fee calculation.
Side note: See my earlier post on the 2020 law that enabled non-traded BDCs to issue share classes that layered even more fees on to investors. These went to wealth advisors rather than the BDC themselves.
The astute observer may notice two things in the chart: The BDCs that have the lowest hurdle rate generally have a lower incentive fee. Also, the 5 BDCs with the lowest hurdle rate are all non-traded BDCs, including: BCRED- Blackstone, ADS - Apollo, ASIF – Ares, HLEND – HPS/BlackRock, OCIC – Blue Owl.
We have a lot more data on incentive fees (and other metrics). Explore our BDC tool here. There is no paywall for now.
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