Follow the Insiders with These Two High-Yield BDCs

Business development companies (BDCs) are about as popular with investors as Ebola is with the general public.
Year to date, the Market Vectors BDC Income ETF (NYSE: BIZD) is down around 7% (and was down as much as 15% a couple weeks back). By comparison, the S&P 500 is up over 10%.
Historically, BDCs have traded at roughly 75% of the forward P/E multiple of the S&P 500. Today, they trade below 70%. BDCs usually trade at a premium to net asset value (NAV). Today, most trade at a discount.
Investors are concerned that dividend yields are unsustainable. Fitch Ratings recently published its outlook on BDCs, and voiced a few concerns of its own – yield compression, rising leverage ratios, and ventures into off-balance-sheet financing.
But concerns can often mean opportunity. I see opportunity in a couple high-yield BDCs. I’m not alone in my outlook.
Ares Capital Corp. (NASDAQ: ARCC) is the largest publicly traded BDC, with a $5 billion market cap. It’s also one of the higher-yield BDCs, with a 9.5% yield.
Like many BDCs, Ares is on sale. Its shares usually trade at a 10%-to-15% premium to NAV. At the current market price of $16.40, Ares trades at 3% discount to NAV.
Investors are unwilling to pay a premium. Many of them believe Ares’ $0.38 quarterly per-share dividend is sustainable. Their concern isn’t entirely baseless.
Ares earned $0.57 in net income per share in the latest quarter, but net investment income (NII) was only $0.34 per share. Investors look for NII to support the dividend. Ares’ NII failed to do that for the quarter. Despite that, Ares was able to maintain its dividend through its cash reserves and ample borrowing capacity.
Some Ares investors are less concerned than others. Ares insiders, for instance, appear to have taken the shortfall in stride. They’ve bought over 65,000 Ares shares since the beginning of November.
Such robust insider buying points to a sustainable dividend. After all, a dividend cut would lead to a cut in share value. Does it make sense for insiders to pile in and then cut the dividend?
Prospect Capital Corp. (NASDAQ: PSEC) is another BDC that has income investors on edge.
Prospect pays $1.32 in per-share annual dividends. The dividend is parceled out in monthly increments of a little more than $0.11 per share. At today’s parceling and share price, investors are looking at a whopping 14% yield.
Many investors are convinced the dividend is unsustainable. In the recent quarter, Prospect earned $0.24 per share, while NII posted at $0.28 per share. NII increased quarter over quarter, but was still $0.04 per share short of the year-ago figure. Whether it’s earnings or NII, the dividend hasn’t been covered by either in the past six months. Like Ares, Prospect has instead relied on reserves to maintain its dividend.
Investor concern, and subsequent selling, has pushed Prospect’s shares 7% below their $10.47 NAV.
So is Prospect’s dividend sustainable? If we listen to the insiders, the answer appears to be “yes.”
Prospect CEO John F. Barry bought 110,000 Prospect shares this past Monday. In the past two months, Barry has bought 210,000 shares. Other insiders are also on board. Since late August, they’ve bought an additional 56,300 Prospect shares.
Insider buying at Ares and Prospect suggests outsiders should be accumulating, not dispersing, shares. Insiders sell for many reasons, but they buy for only one – to make money.  Ares and Prospect insiders are obviously looking to make money investing in their respective companies.

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