Business development companies (BDCs) are very attractive for investors. It’s hard not to like steady dividend payments and high yields. However, there is a very large range of quality in the BDC space, with a corresponding range of total return results.
Many investors have been burned by chasing the BDCs with the highest yields, rather than looking for investor focused business operations and long term records of positive investment returns.
[ad#Google Adsense 336×280-IA]A business development company operates under the 1940 Investment Company Act, the same law that governs mutual funds and other types of investment funds.
Additional laws governing this type of business require a BDC to provide capital to smaller, privately held corporations. This capital can be in the form of business loans or equity investments.
A BDC can use leverage up to one times its equity, effectively doubling the money one of these companies has available to make small business investments.
Typically, a BDC focuses on making business loans, and often will take a small piece of equity in a client company.
The loans provide cash flow to pay the attractive dividends craved by investors.
Equity investments can produce capital gains to be paid as special or bonus dividends. Business development companies are also required to pay out at least 90% of net income as dividends. This is a rule that ensures a high dividend rate and yield, but makes it a challenge for management to grow the business.
Out of the 40 or so publicly traded BDCs, the majority have produced less than stellar results. One report shows that since the start of 2011, 90% of the companies in the sector have lost share value, with some dropping more than they have paid in dividends to investors. To narrow down the pack, consider these three BDCs with above average investment potential. For comparison, the UBS ETRACS Wells Fargo Business Development Company ETN (NYSE:BDCS) exchange traded note that tracks the sector has a current yield of 9.05% after 0.85% in annual expenses.
Ares Capital Corporation (NASDAQ:ARCC) is the largest company in the BDC sector with a $4.5 billion market cap.
In this case larger is better, allowing ARCC to build a diversified portfolio of investments.
As of the end of July, ARCC had over 200 client companies with investments spread across six types of assets, ranging from first lien senior secured loans to equity investments.
Client companies operate in 16 different business sectors. ARCC last increased its regular dividend rate for the 2012 third quarter. However, it has also paid five additional $0.05 dividends since then. ARCC currently yields 10.15%.
Main Street Capital Corporation (NYSE:MAIN) is a stock that should be in every income investor’s portfolio.
As the most conservatively managed BDC, MAIN is one of the few with a growing share price over the last four years.
MAIN is well diversified with 190 portfolio investments.
The company has increased its dividend rate every year, typically twice each year.
Special dividends have also been paid when equity investments pay off with capital gains. Finally, MAIN is a monthly dividend stock, dropping cash into your brokerage account every 30 days. The stock’s current yield is 7.8%.
For a much more speculative BDC play, take a look at TriplePoint Venture Growth BDC Corp (NYSE:TPVG).
This $170 million market cap company provides venture capital debt investments with equity kickers that could pay off big when a client company goes public or gets acquired.
Investments are focused on technology, life sciences, and other high growth companies.
The regular dividend rate has been increased twice since the March 2014 IPO. TPVG currently yields 13.9%. These three BDCs offer solid return potential. There are a few others that have similar potential. Be sure to look at a BDC’s track record as well as the yield before you invest.
The rules that control these companies make it hard for a dog to turn itself around and become a greyhound.
— Tim Plaehn
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Source: Investors Alley
Position: Long MAIN