Business development companies (BDCs) are enjoying a renaissance. Designed to lend money to private middle-market businesses, these investment vehicles are growing rapidly, taking market share from other lenders and providing investors, both institutional and individual, with the potential for returns that are above those available on traditional fixed-income products.

BDCs weren’t always so successful. They were created in 1980 to boost lending to private firms. Initially they were not used much and when they were, they were plagued by high fees and poor management. Investors who remember them mostly recall a bad experience.

Fast-forward 35 years and the picture begins to get a lot brighter. A new wave of managers, including my own firm, Blue Owl Capital, has entered the industry and brought with them deep experience in corporate lending and a true institutional approach. They also showed up at a time when the need for their skills was growing. Banks have been retreating from direct lending since the 1990s. In the meantime, private equity firms, whose growth has exploded, need reliable partners who can supply the debt to finance their deals.

In a recent research report, Goldman Sachs estimated there will be another $430 billion in direct lending origination between now and the end of 2023. The whole industry totals $300 billion today. That growth is good news for lenders, but also an opportunity for investors.

As the BDC industry matures, it has seen considerable innovation around its basic design. Today, BDCs can be publicly traded on a stock exchange or private, with the intention to go public in the future or to stay private forever. Some funds require investors to commit money only at the outset and fund over time; others allow investors to deploy all their capital up front. The various types of BDCs also offer different degrees of liquidity. The variety means investors can find funds that meet their specific needs.

Better managers, the reduction in bank activity and these structural innovations within BDCs have all coalesced to a timely, compelling opportunity. In our discussions with some of the largest asset allocators in the world, the difficulty of finding a compelling yield in the current environment is apparent: spreads are as tight as ever, rates are low with 10-year Treasuries at 1.25 percent, and the potential risk of inflation and rising rates is looming.

There are a number of features that make BDCs desirable as investment vehicles and a potential solution to the challenging investment landscape faced by investors today. Here are the most important:

• Exhaustive due diligence. Direct lenders do not buy businesses, but before they make loans, they examine companies with the same thoroughness a buyer would. The result: By the time a loan is made there is a high degree of confidence it will be paid off.
• The yields are attractive. In a world of ultra-low interest rates where investors are worried about inflation, BDCs can offer higher yields. According to Goldman Sachs, direct lending funds have yielded about 7 percent over the past few years, higher than rates available in the markets for high-yield bonds or leveraged loans.
• A high degree of safety. BDCs make loans of all types, but a large percentage are senior secured loans, meaning the loans are high up in the capital structure and well protected in the unlikely event of a default. Furthermore, loans made by direct lenders typically have better documentation and stronger covenants than their counterparts in the public market. Finally, BDCs are increasingly lending to larger companies, which tend to be more resilient in times of stress. Taken together, all of this provides BDC lenders with better protection against underperforming borrowers or market disruptions.
• BDCs are regulated and transparent. BDCs are registered under the Investment Act of 1940, must publicly file regular reports on their performance and must meet a number of statutory portfolio diversification and other requirements.

In any discussion of BDCs, one question comes up a lot: Where do we go from here?  We think the demand for direct lending will continue to grow, fueled by private equity firms, who are sitting on trillions of dollars of dry powder and increasingly prefer the certainty and flexibility of working with direct lenders.

As a senior secured floating-rate strategy, we believe investors who have not yet considered BDCs should give them a serious look.

Sean Connor is a managing director at Blue Owl Capital.