Philadelphia-based Franklin Square Capital Partners, with $6.9 billion under management, specializes in providing investors access to asset classes, strategies and managers generally reserved for the largest institutional investors. The firm was behind the industry’s first non-traded business development company but also likes senior secured loans as a source of diversification for its investors. Franklin Square CEO Michael Forman spoke recently with FINalternatives Senior Reporter Mary Campbell.
What is the attraction of business development companies and senior secured loans as investments?
Business development companies provide individual investors with access to investments in private U.S. companies which historically have been available to only the largest institutions. BDCs are governed by the Investment Company Act of 1940, which provides a high degree of investor protection and transparency. While BDCs can invest across a private company’s capital structure, Franklin Square’s funds invest primarily in senior secured loans.
Senior secured loans offer individuals an alternative way to diversify their income strategy. Due to their favorable position at the top of the corporate capital structure and floating interest rates, senior secured loans can offer downside protection in the event of a default and can protect against inflation and rising interest rates. This floating rate feature can also add an element of diversification to an investor’s portfolio as senior secured loans are generally not well correlated with traditional asset classes such as stocks, government bonds and commodities.
How large an asset class is this? Is it growing?
Since its inception in the early 1990s, the senior secured loan market has grown to over $1 trillion in size. As the loan market has grown, so too has its investor base, which today includes both individual and institutional investors seeking the diversifying potential of the asset class.
What factors do you weigh when evaluating loans for potential investments?
Franklin Square leverages the experience and investment expertise of our sub-adviser, GSO Capital Partners, the credit platform of The Blackstone Group, to identify and source investments for our funds. When evaluating potential investments for our portfolios, each investment is put through a rigorous dual underwriting process by the investment committees of both Franklin Square and GSO. We will target investments in stable companies with, among other things, positive cash flows, proven management teams, leading and defensible market positions and strong sponsorship by high-quality private equity firms.
How liquid an investment is a BDC?
There are two general types of BDCs—traded and non-traded. Traded BDCs can be bought and sold on a national securities exchange, such as the New York Stock Exchange or NASDAQ, just like any listed stock. Non-traded BDCs typically provide a limited degree of liquidity at predetermined time periods, often on a quarterly basis. We believe that the non-traded BDC structure can benefit those investors who are willing to forgo daily liquidity and prefer to invest without the excess volatility and equity market correlation associated with publicly listed shares. In addition, the non-traded structure allows the manager to take a long-term investment view, matching the long-term investment nature of senior secured loans.
This type of investment can be influenced by inflation and interest rates; what is your current take on the direction of the U.S. economy with regard to both these factors?
Even with the recent rise in 10-year Treasury yields, long-term interest rates remain near their historical lows. If interest rates continue to rise, we believe that the floating rate nature of senior secured loans can offer a hedge against rising interest rates and inflation, as the loans will reset to prevailing market rates on a regular basis. Senior secured loans generally exhibit low correlation to other asset classes, such as stocks and bonds, which can help to lower the risk of an investor’s portfolio without sacrificing return.