Business Development companies: What you need to know

The expense ratios of some Vanguard funds appear to have increased recently, but appearances can be deceiving. Fund expense ratios now reflect guidance from the Securities and Exchange Commission (SEC) about reporting requirements for funds that hold business development companies (BDCs), not any change in the costs incurred by fund shareholders. 

So what does this mean? In addition to investing in individual stocks and bonds, mutual funds can also invest in mutual funds and other investment companies, including business development companies (BDCs).  A BDC is a special type of closed-end investment company that tends to invest in small, developing, and often private companies. Like an automaker, retailer, or any other operating company, a BDC incurs expenses such as employee salaries. These costs are not paid directly by a fund that owns shares in a BDC, just as the costs of labor and steel are not paid directly by a fund that owns shares in an automaker.

SEC rules nevertheless require that any expenses incurred by a BDC be included in a fund’s expense ratio as “Acquired Fund Fees and Expenses.” The expense ratio of a fund that holds a BDC will need to overstate what the fund actually spends on portfolio management, administrative services, and other shareholder services by an amount equal to these Acquired Fund Fees and Expenses. The Acquired Fund Fees and Expenses do not impact a fund’s total return or index tracking error and are not included in a fund’s financial statements, which provide a clearer picture of a fund’s actual operating expenses.

The following  funds own shares of BDCs because either the advisor considers them to be a good investment relative to other stocks in the advisor’s investment universe or the fund is an index fund and the BDCs are included in the fund’s target index:

  • Explorer Value Fund
  • Extended Market Index Fund
  • Institutional Total Stock Market Index Fund
  • Financials Index Fund
  • Market Neutral Fund
  • Russell 2000 Index Fund
  • Russell 2000 Value Index Fund
  • S&P Mid-Cap 400 Index Fund
  • S&P Mid-Cap 400 Value Index Fund
  • Small-Cap Index Fund
  • Small-Cap Value Index Fund
  • Strategic Equity Fund
  • Strategic Small-Cap Equity Fund
  • Total Stock Market Index Fund
  • Vanguard Variable Insurance Fund Small Company Growth Portfolio 


All investments are subject to risk.  Prices of mid- and small-cap stocks often fluctuate more than those of large-company stocks. 

An investment in Vanguard Market Neutral Fund is subject to market risk, strategy risk and manager risk. Although the Fund seeks to minimize market risk, there is no guarantee that the use of long and short positions will succeed in limiting the Fund’s exposure to US stock market price movements, industry or sector swings, and other risks. It is possible that the stocks the fund holds long will decline in value at the same time that the stocks it holds short increase in value, thereby increasing potential losses to the fund. The fund’s loss on a short sale is potentially unlimited because there is no upper limit on the price a borrowed security could attain. This risk could be reduced to some degree because each advisor independently manages a portion of fund assets. In a multi-manager structure, one advisor’s gain on a short position could be partially or totally offset by a decline in the other advisor’s long position in the same security. The Fund is also subject to manager risk, the risk that the manager will not be successful in generating positive alpha with the exposure to stocks held long and stocks held short. As with any actively managed fund, investors face the possibility that decisions made by the fund’s advisors may not succeed, potentially causing the fund to underperform other funds with a similar investment strategy. Foreign investing involves additional risks including currency fluctuations and political uncertainty.


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