These BDC stocks offer high yields in a low-rate world

BDCs are a public bet on private credit. They raise capital from investors and lend to small and medium enterprises.

Illustration by Benedetto Cristofani

Text size

In a world of low interest rates, the promise of a dividend yield of over 7% seems too good to be true, and it usually is for most stocks. But there is a corner of the market where rich dividends are attractive and arguably under-promoted. Welcome to the world of business development companies.

BDCs are a public bet on private credit. Established by Congress in 1980 to spur investment in private small and medium-sized businesses, BDCs raise capital from investors to buy debt and equity portfolios in companies typically valued at less than $250 million. . Like real estate investment trusts, BDCs distribute at least 90% of their income to shareholders and pay no corporate income tax.

Annual dividend yields of 7% to 10% are typical. By comparison, a high-yield bond benchmark, the ICE BofA US High Yield Index, has an annual return of around 5.5%, and the


S&P500

the index yields 1.4%. Even with bond yields expected to rise as the Federal Reserve begins to raise interest rates, BDCs offer attractive returns, with room for growth.

They have no shortage of targets. An influx of capital into private equity funds has led to more leveraged buyouts to fund, just as traditional banks shunned riskier lending in the post-global financial crisis era.

Private credit assets under management surpassed $1.2 trillion at the end of 2021, according to data provider Preqin Global, after a decade of 13.5% annual growth. Preqin expects the total to reach $2.7 trillion by 2026.

Loans from BDCs tend to have floating interest rates, which means that interest income should increase as benchmark rates rise. On the other hand, BDCs tend to borrow at fixed rates, which keeps their costs stable.

The large BDC category is trading around one times NAV, a slight premium to its long-term historical average closer to 0.95. Investors shouldn’t count on appreciation driven by net asset value growth — BDCs’ total returns come from their quarterly dividend payouts.

BDC / ticker Recent Price Net asset value Price/NAV Market value (mil) Yield
New Mountain Finance / NMFC $13.64 $13.49 1.01 $1,342 8.8%
Barings BDC / BBDC 10.84 11:36 0.95 708 8.5
Owl Rock Capital / ORCC 14.98 15.08 0.99 5,911 8.3
Ares Capital / ARCC 22.11 18.96 1.17 10,588 7.6
Blackstone / BXSL Secured Loan Fund 28.10 26.27 1.07 4,768 7.5

Sources: FactSet; company documents

So what’s the problem ? BDC fees are high – lenders typically charge a management fee of around 1.5%, plus incentive fees of around 10% to 20%. These fees raise the bar for returns. And with illiquid holdings and portfolios that can be a bit of a black box, investors are betting on a BDC’s manager to be a good steward of their investment.

“It’s not about income; it’s not a story of multiple expansions,” says Chris Tessin, senior portfolio manager and managing partner at Acuitas Investments in Seattle. “It’s more about assessing the quality of BDC’s management and being comfortable with a diversified portfolio.

the


BDC VanEck income

exchange-traded fund (ticker: BIZD) has some $574 million in assets. It tracks an industry index and is the largest individual shareholder in most public BDCs. With an annual dividend yield of 8.1% and a management fee of 0.4%, the ETF is a simple way for investors to add diversified exposure to BDC to their portfolios.

“It’s a great way to access private credit for many investors who would otherwise struggle to access it,” says Brandon Rakszawski, director of ETF product development at VanEck. “Many of these investments are restricted to institutional or accredited investors, or much less liquid vehicles.”

But the ETF is rather heavy. Two BDCs—the $10.6 billion


Ares Capital

(ARCC) and the $6.6 billion


FS KKR Capital

(FSK) — represent approximately 30% of the portfolio. The ETF’s top 10 holdings make up around 70% of total assets. Investors willing to take a more active approach can balance their exposure more evenly with individual securities.

“Generally, you want to diversify into at least five BDCs that don’t all target the same end market,” says Robert Dodd, analyst at Raymond James. “You want to diversify in reality, not just in name.”


Blackstone Secured Loan Fund

(BXSL),


Owl Capital

(ORCC), and


Financing of the new mountain

(NMFC) are high quality BDCs backed by established institutions. All three invest in low-risk senior debt, which is the first to be repaid in the event of default. It’s an attractive approach for a potentially volatile period ahead.

BDC Ares, which went public in 2004, is among the most diverse in the end markets and types of loans it makes. Some BDCs, including


Prospect Capital

(PSEC) and


Main Street Capital

(MAIN), employ higher octane strategies by also investing in more junior or unsecured debt or equity securities of corporate capital structures. This makes them more sensitive to trade terms.

Raymond James’ Dodd has about a dozen outperforming ratings in the BDC space, but only one strong buy:


Barings BDC

(BBDC). It has relatively low risk and a differentiated portfolio, and it just acquired another BDC, notes Dodd. It has the potential for dividend growth and net asset value appreciation. “It’s a hard combination to find in a BDC,” he says. Dodd has a price target of $12.50 for Barings, around 15% above recent levels. The stock yields 8.5%.

High returns are never without risk, but diversification and a long-term view can help tip the risk-reward equation. In the current climate, more investors should consider BDCs.

Write to Nicholas Jasinski at [email protected]

About Meredith Campagna

Check Also

Bahamian Securities Regulator Freezes FTX Assets

The Bahamas Securities Commission (BSC) froze the assets of FTX Digital Markets (FDM) and “related …