In a gesture of convenience for investors, S&P and Russell say ‘sayonara’ to BDCs in their broad indexes.
S&P Dow Jones Indices and Russell Indexes have decided to jettison business development companies (BDCs) from their broad U.S. indexes to streamline the way mutual funds and ETFs must account for their presence in a portfolio.
S&P’s decision to nix BDCs affected its biggest and most famous indexes, including the MidCap 400 and the SmallCap 600, David Blitzer, chairman of the index committee at S&P Dow Jones Indices said in a telephone interview. BDCs are typically closely held entities that exist to invest in relatively small and dynamic pockets of the economy. They are favored by investors for the sometimes-huge yields they provide.
Behind the index firms’ decisions is the fact that BDCs are considered mutual funds. As far as that goes, U.S. financial regulations strictly limit how much of other mutual funds a given mutual fund can own. More to the point, a BDC that’s included in a fund-of-funds mutual-fund structure—including in an ETF wrapper—is reflected in so-called acquired fund fees that are expressed in expense ratios.
Blitzer said that S&P’s decision, made last month, doesn’t amount to a judgment that BDCs are bad. But he stressed that their presence in a diversified mutual fund or ETF can be more trouble than they’re worth.
“If you put one or two BDCs in something like the S&P MidCap 400, you really don’t gain too much by those two companies being in there, but you really gain a whole lot of aggravation and expense,” Blitzer said, saying the convenience easily trumps the trivial loss of diversification. “And the expense goes back to the individual investor.”
Acquired Fund Fees
That expense that gets passed on to investors as acquired fund fees can by eye-popping too.
Just look at the Market Vectors BDC Income ETF (BIZD).