Heads-up investors – particularly income-focused investors: The landscape is shifting right now, and if you don’t navigate it carefully, it could end up costing you money. A lot of money.
It’s not fair, but it’s the hand we’ve been dealt. Rates have been so low for so long that traditional fixed-income investments either won’t cut it or just barely will. To make matters worse, interest rates are starting to rise, which could make your existing holdings worth less money. The fixed-income math is impossible to argue with: Income-generating investments fall in price as rates rise, so the yield remains competitive with new offerings.
The good news, as I’ve been saying over the past few weeks, is that there are investments out there that can wipe these worries and hassles out. The one I’m about to show you has a nice “kicker” too – built-in protection and highly confident insiders buying shares on the open market. After all, if the people overseeing the investment have confidence that there will be inflation protection and strong yield, then we should absolutely go along for the ride.
For everything that this class of stocks has, they generally aren’t expensive or popular stocks – at least not with the Reddit crowd. That means more upside at cheaper prices for us.
Very Special Stocks with Very Good Returns
Business development companies, or BDCs, are funds that lend money to the middle market of American industry.
This kind of business has been around a long time, but the market really exploded after the financial crisis. Post-crisis changes in the banking industry opened up opportunities for BDCs to become more involved in lending to companies than ever.
Big-picture, that’s good for the economy, but I love them because they offer one of the best income opportunities available today.
One of my favorite BDCs is FS KKR Capital Corp. (NYSE: FSK).
This BDC is co-managed by FS Investments, an alternative-asset investment firm that has been active in BDCs for 16 years. It co-manages the company with the world-class credit team from KKR & Co. Inc. (NYSE: KKR), one of the top-performing private equity and credit investors in the world.
The two firms were managing two BDCs together… until last year, when they decided to merge them á la peanut butter and chocolate to form the second-largest business development company in the United States with over $16 billion in assets.
FS KKR Capital focuses primarily on upper middle-market companies with $50 million to $100 million or more earnings before interest taxes, depreciation, and amortization (EBITDA). In addition, the team managing the fund prefers to focus on senior secured loans so that they have a much higher probability of getting paid back in the event something goes wrong with the borrower’s business.
The FS KKR Capital team has been doing this type of lending for a long time, with around 90 years of combined experience. CEO Michael Forman is the co-founder of FS Investments – you might remember it as Franklin Square – and has been involved in the alternative credit markets for 35 years.
Co-President Daniel Pietrzak is part of the leadership team at KKR Credit and has been involved in middle-market lending for 23 years.
Co-President Brian Gerson is the head of private credit at FS Investment and has been involved in alternative credit for 32 years.
What this long tenure tells you is this team has seen several business and economic cycle stages and is prepared for whatever might happen.
The investment team at FS KKR has access to all of the KKR private credit division that is managing over $170 billion in private and alternative credit strategies. It can use this team of almost 100 credit professionals to help source, evaluate, and originate loans to middle-market companies.
The evaluation process is strict. It uses the same approach to evaluate a loan candidate that the KKR private equity team uses when buying a company. It wants to know everything about the business and how it might fare under different economic scenarios.
It is the lead or sole lender on 95% of the loans FS KKR makes. About 70% of the portfolio is senior secured debt, so it will be among the first to get paid in case of problems.
Even better yet, with the prospect of rates moving higher in 2022 and beyond, almost 90% of the portfolio is floating rate. If rates go higher, so do the borrower’s loan payments, so we have a substantial measure of protection against rising rates.
Currently, FS KKR is priced at an attractive valuation of 80% of book value. That’s like getting a stock for 20% off, for all intents and purposes. And, since it’s me you’re talking to, you know the yield’s going to be out-of-this-world. It’s north of 11%, to be precise.
Insiders have been buying a lot of stock in recent months. Insiders sell for all kinds of reasons, but they only buy when the stock is going up. That gives me a great deal of confidence in the future of this BDC. This is an excellent addition to an alternative income portfolio at the current price of just under $22 right now.
— Tim Melvin
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Source: Money Morning