Prepare your shopping lists, because it is almost time to jump.
Just recently, I explained to investors that as contrarians, we only want to fully dive into the market when we have a clear advantage – the kind of advantage you get when Wall Street has completely capitulated:
“We only want to fully invest when the regular investor has thrown in the towel. And there are plenty of indicators that can tell us exactly when our time is right. Consider, for example, the very popular CNN Fear/Greed Index. guarded, which sits at 26 as of this writing.
It was barely a week ago. Now that the market has dipped into bearish territory, the Fear/Greed Index is really starting to move in our direction. We’re not there yet – again, just a few weeks ago the index was down to six!– but we are now at the point where we should be ready to jump at any moment.
So what are we buying?
Three of the best income letters
It’s a rare asset class that can even offer returns of 7% or 8% at times, but a pair of niche investments regularly offer high single-digit and even double-digit returns.
And one of those asset classes is the modest business development firm, or BDC.
BDC: well over 8% annual return, on average!
BDCs don’t get much attention from the typical financial media, and for good reason: they’re complicated and don’t make for easy, exciting stories.
If you’re not familiar, business development corporations originated in the 1980s as an act of Congress, which stimulated this new asset class to encourage investment in small and medium-sized businesses, the same way they created real estate investment trusts (REITs) in the 1960s to do the same with real estate.
BDCs have filled a big void in the business world. For years, big banks have shunned small businesses because of their outsized risk. And if they would deign to provide financing to an upstart, they would charge an arm and a leg for it.
Business development companies have helped fill this unmet need.
BDCs provide all kinds of debt, equity and other financing to companies in countless sectors. Which means business development companies actually have diverse portfolios of private company stakes that you and I could never invest in alone.
If that sounds like private equity…well, it is, and that’s the real appeal of BDC.
As a result, BDCs have diversified portfolios of private companies that none of us could invest in alone. But unlike the PE, which typically requires investors to stake around a million to play, you and I can jump into a BDC for the price of a single share, usually between $10 and $100.
And although they invest in small businesses where growth is often the first trait, BDCs are actually high-yield monsters. Indeed, like REITs, BDCs do not have to pay federal tax…as long as they return at least 90% of their taxable income to shareholders in the form of dividends.
And one last thing before I show you a few of these high-yield coins: business development companies are a particularly stellar coin for this particular moment in time. This is because many of their portfolios are heavily, if not entirely, invested in floating rate loans, which means that their rates (and therefore their profit margins) increase as interest rates rise.
With all that out of the way, let’s take a look at three BDCs that return an incredible 10.7% on average.
Apollo Investment (AINV)
Dividend yield: 10.0%
Let’s start with Apollo Investment (AINV), which primarily provides debt, but also equity, investments to private middle-market companies (Apollo defines this as companies with revenues between $50 million and $2 billion). Right now, the company is trading at just 70% of its net asset value (NAV), at least signaling the potential for a glaring value buy.
By the way, if you’re thinking, “Wait, this Apollo?”, yes, there is a connection – Apollo Investment Management, LP, a subsidiary of Global Apollo Management
Currently, AINV has an investment portfolio of $2.52 billion that covers 139 companies in 26 sectors. Core business loans make up approximately 83% of this portfolio, primarily (94%) via senior loans to businesses in the healthcare and pharmaceutical, technology, business services and other sectors . It is important to note that 99% of these loans are variable rate in nature, so from this point of view, AINV is well positioned.
Another part of his portfolio has been much more problematic. The Merx aircraft leasing portfolio, which represents approximately 12% of its assets, suffered significantly in 2022 due to its exposure to Russia. From now on, the BDC plans to lighten this branch: “AINV intends to reduce its investment in Merx by selling aircraft and de-emphasizing its maintenance activity.”
The thing is, Merx offers a substantial double-digit return. That’s a concern given Apollo’s track record.
AINV distributes both regular dividends and special “top-up” dividends as earnings permit, which is generally a sign of a safer and more conservative dividend program. This is not the case with Apollo Investment, which has made three dividend cuts since 2011 which have collectively seen its quarterly payout decrease by 57%.
In other words, AINV is cheap, but given its unreliable dividends, it hardly seems like a value.
Barings BDC (BBDC)
Dividend yield: 9.3%
Barings BDC (BBDC) looks a little more promising.
With a 20% discount on NAV, it’s not as cheap like Apollo, but still a huge bargain if Barings fundamentals are checked.
Barings, by the way, was not always called Barings. Until August 2018, the company was called Triangle Capital, a BDC that served lower and middle market companies. And he tended to frequently shoot himself in the foot. Triangle has repeatedly canceled bad investments and hacked its dividend. I said in November 2017 that CEO Ashton Poole was “considering all options”, and he did: the company would eventually change its name and ticker about a year later.
But it wasn’t just a PR overhaul. The name change reflected the new outside adviser, global financial services firm Barings, and the company set to work revamping BBDC’s portfolio. Currently, Barings invests primarily in senior secured private debt investments in “well-established” middle-market companies across many sectors. Its loans typically have terms of five to seven years and bear interest at rates ranging from LIBOR+450 to LIBOR+650.
Where Barings stands out is its diversification: its assets are spread between US middle-market companies and middle-market companies in Europe and Asia-Pacific, but it also owns the portfolios of two BDC acquisitions – MVC Capital and Sierra Investment Corporation (SIC) – crossed – investments in the platform, and certain cash and short-term investments.
This diversification and high-quality holdings have yet to pander to investors, at least from a price point of view. BBDC has returned slightly less than a benchmark BDC fund since its rebrand, but the dividend has soared, with Barings upping the ante nearly every quarter since then.
FS KKR Capital (FSK)
Dividend yield: 12.7%
FS KKR Capital (FSK) is, together with AINV, among the cheapest BDCs at the moment with a 30% discount on NAV.
But given its poor performance over time, one could say that FSK should trading at at least somewhat depressed levels.
FS KKR Capital provides financing to private companies in the middle market, primarily by investing in senior secured debt (69%), although it also deals in subordinated debt and other financing. It includes 193 portfolio companies spread across a number of industries, including software and services, capital goods, real estate, retail and more.
FSK also has exposure to Credit Opportunities Partners JV, a joint venture with South Carolina Retirement Systems Group Trust which invests capital in a range of investments.
And 87% of FS KKR Capital’s debt investments are floating rate, so investors here get built-in protection from the Fed. In fact, FSK said a 100 basis point increase in the Fed’s benchmark rate would boost its quarterly net investment income (NII) by 4 to 5 cents per share.
This is attractive, as is the growing credit quality of FS KKR Capital’s portfolio. Its dividend is less so, which has been moving in the right direction lately, but is far from reliable.
To FSK’s credit, its most recent quarterly NII was enough to cover its rising payout, now at 68 cents for the most recent quarter. But clearly, this BDC is comfortable operating its dividend program at the margin.
Brett Owens is Chief Investment Strategist for Opposite perspectives. For more income ideas, get your free copy of his latest special report: Your early retirement portfolio: huge dividends, every month, forever.