A new kind of “Murder Hole”

Well, this doesn’t happen on a regular basis anymore, but I just got pitched (via email and voicemail) a new breed of terrible investment.  The offer was for a non-traded (that’s inside speak for illiquid, you won’t be able to sell it) Business Development Company (BDC) investing in the debt of private companies.  Oh goody.  Let’s see the pitch:

“Allows your clients to have access to institutional-like investing similar to what was previously only available to endowments, pensions and high-net-worth individuals.”

This is the “you’re special” pitch.  Wirehouse brokers have been using this one on high-net worth investors for years.  You reach a certain level of wealth, and suddenly you get to see what’s behind the curtain!  See, the financial industry likes people to believe that they keep the really good stuff for the wealthy.  In fact, the wealthy are just more profitable to fleece, and there is no level of wealth that justifies an overly complex investment strategy and high fees.

“Provides individuals an opportunity to invest in the debt of privately owned American companies.”

If lending money to these private companies is such a great opportunity, why is it in front of me?  Why can’t these great privately owned companies borrow money from a bank, venture capitalist, angel investor, friends or family like every other successful small business? Generally speaking, because these companies have tried to borrow money elsewhere and have been unable to.

“Has an annualized distribution1 increase to 7.78 percent effective April 1, 2014, and an average duration on the portfolio of just over two years.”

See that little footnote marker?  Here’s the accompanying disclosure:

“1 Distributions are not guaranteed and are subject to change. The annualized distribution rate is calculated by dividing the annualized distributions by the offering price of $10.34 as of April 1, 2014.”

One thing that products like this and things like it (such as non-traded REITs) get away with is this “distribution yield” idea.  These products raise investor capital and immediately start paying out interest before any actual investment is made. Since there aren’t any investments to generate income, this “yield” essentially represents a return of investor capital. The products continue with these distributions, eventually hoping that actual income in the product will catch up. And since this is a BDC, they don’t have any actual investment opportunities identified yet.  So you are giving money to the manager of the program in hopes that they will find opportunities to buy the debt of private companies that will make enough money to support the stated distribution yield.  And, if it doesn’t go well, you can’t sell it on a secondary market for anything close to what you paid for it.

Good luck!

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Murder Holes: Built to Fail

The Worst Investment You’ll Ever Make

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