Buy when others sell; sell when others buy. Repetition has reduced this bromide to cliché, but it hasn’t reduced its imbedded truth.
Though few investors posses the fortitude, buying when others are selling (and vice versa) frequently leads to outsized wealth. The key is to look to the horizon in order to divine the possibilities that lie in the distant future.
Business development companies (BDCs) – companies that borrow at one rate and lend at a higher rate to small and mid-sized companies – offer wealth-enhancing possibilities for future-focused income investors. “Others” have been selling BDCs in droves.
I sense opportunity. Earning the spread between costs of funds and the rate earned on those funds has always been a sturdy cash-flow business when done intelligently. Many business development companies do it intelligently. In essence, they do what traditional banks used to do before becoming intoxicated by the fast money of carry trade and derivatives speculation.
Because BDCs are reliable high-yield investments, they tend to trade within a narrow range. Therefore, a 4% or 5% movement is significant – and, in this case, a buying opportunity. I say that because nothing has fundamentally changed. For most BDCs, it’s business as usual.BDCs have taken a glancing blow to the chin, losing 4% – to – 5% of their equity value in the past month. To be sure, that’s a trifle compared to the oscillating daily share price of companies like Tesla Motors (NASDAQ: TSLA) and 3D Systems (NYSE: DDD), but the comparison is between apples and oranges.
So why the opportunity?
Last month, Standard & Poor’s and Dow Jones announced they would jettison BDCs from their respective indices. Earlier this month, Russell Indexes followed suit, announcing it would drop business development companies starting in June.
The institutional exodus was instigated by fees: An ETF must list its own fees, as well as those of any funds it might own. The SEC recently slotted BDCs with other funds, so ETFs will have to report a pro-rata share of the BDCs’ fees, which can run as high as 7% annually. Most ETFs would rather not report, hence the sell off.
It’s all convoluted and quite opaque, and nonsensical really. The “fees” associated with BDCs aren’t fees; they’re expenses, much like the expenses incurred by any bank or lender. Nevertheless, the large index providers and the ETFs that ape them would rather switch than fight.
Their loss is an individual income investor’s gain, particularly if an individual income investor is interested in picking up yield in two of the better BDCs.
2 High-Yield Business Development Companies
Ares Capital Corp. (NASDAQ: ARCC) is one of the better, and larger, BDCs, with a $7.6-billion investment portfolio composed of 193 different companies. Ares lends and finances America’s basic industries: healthcare, energy, retail, consumer products, education, etc. It focuses on businesses with $20 million to $200 million in annual sales and a history of stable cash flows.
These stable cash flows, in turn, have enabled Ares to continually raise its dividend, and to periodically supplement rising dividends with “special” dividends.
Thanks to recent selling by the indexed-institutional crowd, investors can pick up more income and yield for their money. In the past month, Ares shares are down roughly 5%, which has pushed the yield up to 8.7%.
Even more income and yield can be found in Prospect Capital Corp. (NYSE: PSEC). Like Ares Capital, Prospect lends to America’s basic middle-market businesses, only on a slightly smaller scale. Prospect’s investment portfolio is valued at $5.2 billion and comprises 130 different companies.
Prospect doesn’t pay special dividends, but it does pay monthly dividends. What’s more, it pays them at a rate that generates a 12.1% yield on its recently discounted share price.
Institutional “others” are selling two of the better BDCs. That tells me that individual income investors should step up and consider buying two of the better business development companies they’re selling.
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