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FS KKR Capital: Was BDC Investment Too Risky For Some Investors?

FS KKR Capital Corp. (NYSE: FSK) may be the second largest business development company, but that doesn’t necessarily make it a safe proposition for everyday investors—especially given the risks investors already face when they invest in BDCs generally. In fact, FS KKR has suffered hundreds of millions of dollars in losses since it was created, with one analyst recently cautioning investors not to hold their FS KKR investments in a recession scenario. 

What Are Business Development Companies?

Business development companies, or BDCs, are closed-end development funds that allow retail investors to invest in small or midsize businesses, and in some cases distressed businesses. As the Securities and Exchange Commission’s investor resources explain, BDCs are much like mutual funds or exchange-traded funds in that they make their investments using money pooled by a large number of investors, whether retail or institutional. The investors then receive shares in the BDC whose value rises or falls according to the BDC’s performance. 

What Are the Risks of Investing in BDCs?

BDCs themselves are regulated by the SEC, but the companies they invest in may not be. As many of the underlying businesses are relatively small, and because they may themselves be experiencing financial difficulties, an investment in a BDC comes with the risk that those underlying businesses might “be more likely to go out of business or default on their debts,” the SEC explains. And because many of them are private businesses that don’t make public financial disclosures, investors may not be able to access much information about them. BDCs can also use leverage to make their investments, putting investors at risk of enhanced losses. While many promise large distributions, they might also come with substantial fees and commissions, especially compared to mutual funds and ETFs.

Investors should also be aware, per the SEC, that the “market price for BDC shares may be greater or less than the shares’ net asset value,” or NAV. In other words, when investors trade their shares at the current market price, they may be selling at a premium (when the price is higher than the NAV) or at a discount (when the price is lower than the NAV). “If you purchase shares at a premium, you are paying more than the current value of the underlying investments,” the SEC notes. “If you purchase shares at a discount, you are paying less than the current value of the underlying investments, but you may not be able to sell the shares other than at a discount.” This creates even more risk for investors. 

Then there are non-traded (or private) BDCs, which pose the same risks as any non-traded investment products: chiefly, that of illiquidity. In 2016 Financial Industry Regulatory Authority warned investors to exercise caution regarding non-traded BDCs, writing that they expose investors “to high commissions and fees, illiquidity risks and uncertainty regarding the time-period BDCs will hold funds before they are invested.” 

What Is FS KKR Capital Corp.?

FS KKR Capital Corp. is the product of a merger between multiple private BDCs. In 2018, per The DI Wire, Corporate Capital Trust Inc and FS Investment Corporation merged to form FS KKR Capital Corp. In 2020, FS Investment Corporation II, FS Investment Corporation III, FS Investment Corporation IV, and Corporate Capital Trust II merged to form FS KKR Capital Corp II. Finally, FS KKR Capital Corp and FS KKR Capital Corp. II merged last year to form one single entity operating as FS KKR Capital Corp. When that merger was initially announced in 2020, FS KKR Capital Corp. II said it was “looking to take advantage of dislocations in the market caused by the coronavirus pandemic,” according to Bloomberg. 

Its investment advisor’s website boasts that FS KKR has 192 companies in its portfolio as of June 30, 2022, with 18% of its fair value in its top 10 portfolio companies. Of its total investments, 71% are in senior secured debt; of its debt investments, 87% are floating rate. It is most heavily invested in the software and services sector (16.7%), then capital goods (13.4%), then healthcare equipment and services (12.8%). The other sectors in its top 10 industries include commercial and professional services, real estate, insurance, and media and entertainment.

As Seeking Alpha notes, FS KKR’s share price and NAV both plummeted in early 2020, as the coronavirus pandemic shuttered countless businesses and disrupted global markets. While the entity’s fortunes have improved since, the analysis observes that its leadership’s “appetite for risk created hundreds of millions of realized losses” over the years. Pointing out that “Historically, three-quarters of all BDCs with more than three years of operations have lost NAV since inception,” and that only one BDC in existence during the 2007-2009 crisis ended up recovering NAV, the analysis ultimately suggested that BDC may be too risky to hold during a recession: “The company’s high leverage puts it in a precarious situation, near the regulatory leverage limits,” argued analyst Bashar Issa. “When a recession hits, management will be under pressure to raise capital during economic turbulence, exacerbating dilution risk.”

What If I’ve Already Lost Money Investing in FS KKR?

Of course, what might happen in the future is an entirely separate question that what’s happened in the past. As the Seeking Alpha analysis makes clear, FS KKR is a risky investment, one that may have been unsuitable for retail investors who have already invested in it. High fees, the use of leverage, the potential for unregulated and/or distressed companies in the BDC’s portfolio: all these factors expose investors to substantial risks. Financial advisors who failed to disclose these risks—or who disclosed them but nonetheless recommended FS KKR to clients for whom the risks were unsuitable—may be liable for their clients’ losses. 

Call Carlson Law to Discuss Your Case Today

Carlson Law represents investors involved in claims against financial advisors and investment firms throughout the United States. If you or a loved one have suffered losses investing in FS KKR, please call us at 888-976-6111 or complete our contact form for a free and confidential consultation.

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