DIV 203Lesson 8 of 90 of 9
Internally vs Externally Managed BDCs
Who runs the lender, what they're paid, and why it shows up in your return.
What you’ll learn
- The difference between an internally and an externally managed BDC
- How base and incentive fees work, and what they cost you
- Why fee structures can push managers towards growth and leverage
- Why some BDCs trade well above their NAV
Two BDCs can make similar loans to similar companies and still deliver very different results to their shareholders. One of the biggest reasons is a detail most investors never look at: who runs the BDC, and how they’re paid.
Two models
| Internally managed | Externally managed | |
|---|---|---|
| Who makes decisions | The BDC's own employees | An outside asset manager under contract |
| How managers are paid | Salaries and bonuses, like any company | Base fee plus incentive fee |
| Typical cost to shareholders | Lower | Higher |
| Examples | Main Street, Capital Southwest, Hercules | Ares Capital, Blackstone Secured Lending, Blue Owl Capital |
Most BDCs are externally managed, often by big private credit firms. That gives them access to large deal teams and lots of loan opportunities. The cost is the fees.
How external fees work
- Base management fee: often about 1% to 1.5% a year of gross assets, which includes assets bought with borrowed money.
- Income incentive fee: commonly 17.5% to 20% of net investment income above a hurdle, typically around 7% a year on NAV.
- Capital gains incentive fee: a share of realized gains, net of losses.
Where the incentives can bend
Because the base fee is charged on gross assets, an external manager earns more simply by making the portfolio bigger, including by borrowing more or issuing new shares. If new shares are sold below NAV, existing shareholders are diluted, but the manager’s fee still grows. Incentive fees can also reward taking more risk to clear the hurdle. Many BDCs have adopted shareholder friendly terms to address this, such as fee cuts, a total return “lookback” that reduces incentive fees after losses, or managers buying shares themselves. Read the fee section of the annual report.
Why the market pays up for some BDCs
Main Street Capital is the best known internally managed BDC. Its low costs, a long record of growing NAV per share, monthly dividends that have never been cut and a habit of paying extra supplemental dividends have earned it a share price well above its NAV for most of its history. That premium lets it issue new shares above NAV, which adds to NAV for existing shareholders, a virtuous circle.
That doesn’t make external BDCs bad. Ares Capital, the largest BDC, is externally managed and has a long record of steady results thanks to its scale and underwriting. Structure tilts the odds; execution decides the outcome.
Live comparison
| Ticker | Name | Yield | Pays | 1Y total return | 5Y total return |
|---|---|---|---|---|---|
| MAIN | Main Street Capital Corporation | 6.55% | Monthly | -5.7% | +95.7% |
| CSWC | Capital Southwest Corporation | 12.88% | Monthly | +20.6% | +59.5% |
| HTGC | Hercules Capital, Inc. | 11.26% | Quarterly | +1.7% | +74.7% |
| ARCC | Ares Capital Corporation | 10.20% | Quarterly | +3.2% | +46.2% |
| BXSL | Blackstone Secured Lending Fund | 13.10% | Quarterly | +0.9% | n/a |
| OBDC | Blue Owl Capital Corporation | 12.19% | Quarterly | -9.3% | +25.3% |
| FSK | FS KKR Capital Corp. | 16.01% | Quarterly | -13.1% | +2.3% |
| PSEC | Prospect Capital Corporation | 21.76% | Monthly | -15.6% | -52.1% |
Check your understanding
4 questionsIn an externally managed BDC, who runs the portfolio?
Why can a base fee charged on gross assets create a conflict of interest?
Why does Main Street Capital often trade well above its net asset value?
Is every externally managed BDC a bad investment?
Related lessons
This lesson is for education only and isn’t financial, investment or tax advice. Tickers are used as examples of how things work, not as recommendations. Figures marked as live come from Dividend Duel’s market data and change daily. See our disclosure.