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Investment Ideas

Editor's Note: This is our final article from Chief Market Strategist Dirk van Dijk, CFA, who, we are sad to report, passed away over the weekend.

You may or may not want to see Mitt Romney in the Oval Office next year, but I suspect that most of you would like to invest the way that he has.  Romney made his fortune in Private Equity and Venture Capital.  Normally to invest in that area, you have to be a “qualified investor” and put up a very large sum (normally more than $100,000) and your investment is locked up for several years.  In other words, it is an investment area for the 1%, not the 99% (actually more like for the 0.1%).

There is a way the rest of us can participate in this area.  It is through a group of firms known as Business Development Companies or BDC’s.  These firms generally have relatively small market caps; only a handful of them are over $1 billion. 

They are also structured as pass-through type entities, sort of like REIT’s and MLP’s.  That means that there are some additional tax headaches (K-1’s).  As such they might not be right for your IRA (you are limited to $1,000 of “unrelated business income” in your IRA or 401-k).  However, in return, the BDC’s do not pay taxes at the corporate level, provided they payout virtually everything they earn in the form of distributions (aka dividends).  As a result of all of that, they sort of fly under the radar of most investors.  However, they are one of the best vehicles around for producing a high and growing income stream.

Generally what these firms do is provide capital to small firms, typically firms with Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) of between $25 and $75 million a year.  Often it is a situation where there is a change of control going on, such as the founder is retiring and the executive team wants to buy him or her out. 

The BDC’s tend to get high interest rates for these loans, and usually will get an equity kicker in the form of warrants in the firm.  In a really bad recession, they can be bad places to be as some of those loans will go sour.  However, with the economy showing signs of strength, the credit quality should be improving.

The dividend yields on the group are downright mouth-watering right now.  The average BDC’s yield is now about 5.75% points above the 10-year T-note.  Over the last ten years, when spreads were around this level (from 5.50% to 6.00% and above) the BDC’s have produced a positive total return for investors 91.2% of the time, with an average return of 23.9%. 

The table below shows the BDC’s that currently have market capitalizations over $300 million, and dividend yields of at least 5%.  I also required that they not have Zacks Ranks of #4 (Sell) or #5 (Strong Sell), that they were profitable in 2011 and are also expected to be so in both 2012 and 2013.

By way of disclosure, two of these firms TCAP and ARCC are part of the Income Plus Investor portfolio, and I may well add some of the other names on this list in the near future.  Not only do I think that the dividends are secure, I think they will increase over time.

If you are not one of the super-rich, but would like to be able to invest the way many of them do, BDC’s are well worth investigating.

Company Ticker Market Cap ($ mil) Div Yield Div Yield 5-Yr Avg P/E Using Curr FY Est P/E Using Next FY Est Zacks Rank
Apollo Inv Cp AINV $1,595 13.76% 12.96% 7.89 7.75 3
Fifth Street Fi FSC $682 13.45% 10.06% 9.00 7.85 3
Blackrock Kelso BKCC $593 12.81% 12.60% 9.28 8.01 3
Solar Capital SLRC $779 11.24% N/A 9.54 8.57 3
Triangle Cap Cp TCAP $333 9.82% 10.30% 9.95 9.21 2
Ares Cap Cp ARCC $2,922 9.81% 13.48% 10.29 9.12 2
Main Street Cap MAIN $405 8.85% 10.46% 12.21 11.42 3
Golub Capital GBDC $326 8.53% N/A 12.88 11.45 3

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