April 22 issue. Title: A Smart Alternative to Junk Bonds. Google it to get past the registration block.Thesis: This is like purchasing bonds in microenterprises, where you hire a manager to do the DD for you. The 8-10% distribution is more attractive than the junk bond rates, and some BDCs weathered the 2008 recession well.First, an ETF: BIZDBest bets:Company/ticker, yield, Dividend coverage from stable cash flow (75% minimum, the higher the safer)Ares Capital/ARCC 9.0 75%Golub Capital/GBDC 8.0 77Hercules Tech Growth/HTGC 8.4 86New Mountain Fin/NMFC 9.8 97Theses, according to the article:ARCC: By far the largest cap. Rode out 2008-9 and "continued to pay healthy dividends.GBDC: Shareholder friendly fee structure and particularly picky about risk (thus the lower distribution).HTGC: Tech specialist, negotiates for stock warrants as part of its deals.NMFC: Specializes in companies whose earnings hold up during recessions.Comments welcome. I might take a small stake in one of these.Kat
<<<<ARCC: By far the largest cap. Rode out 2008-9 and "continued to pay healthy dividends.>>>>One of my largest positions. Company is fairly quiet, but they bought out Allied Capital and its portfolio at just about the bottom. Should be holding large capital gains and (hopefully) champing at the bit to bring a few public.
<<<<ARCC: By far the largest cap. Rode out 2008-9 and "continued to pay healthy dividends.>>>><<<<One of my largest positions. Company is fairly quiet, but they bought out Allied Capital and its portfolio at just about the bottom. Should be holding large capital gains and (hopefully) champing at the bit to bring a few public. >>>>I've also held ARCC for a long time but i do remember them trading around the $4 level during the depth of the credit crisis. So they did make it through, but it was a rough ride. I'd like to say that I doubled my position a the lows but the best i can say is that i didn't panic and sell at the lows. Similar situation with NRF.
I no longer follow any of the BDC's. Everyone should understand that there were two large BDC's prior to the 2008 crash:1)Allied Capital aka ALD which essentially went bankrupt. It was the subject of a book by David Einhorn Fooling Some of the People All of the Time. David's big complaint was that ALD did NOT accurately mark all of their investments to market. He had been claiming that for several years before the crash. ALD might have survived intact if the crash hadn't occurred. We will never know. Investors lost something like 90% or 95% in the downfall.2) American Capital aka ACAS survived the crash, but was severely wounded. It peaked at ~ $50 back in 2007. It is currently trading at ~ $14.00, so many investors have lost a lot of principle. They also suspended their dividend in 2009 and it has NOT been restored.So this is what happened the the two largest and "best managed" BDC's.Are you sure that today's BDC's could weather another storm like the last one? Since I don't spend any time on BDC's, I do not have a current opinion. I would certainly be suspicious.Stated differently, any investment that is currently paying 8%+ yields today is HIGH RISK. The market it telling us that, even if we don't want to hear it. . . Thanks,Yodaorange
The Barron's article contains characterizations and observations regarding BDCs but little in the way of fundamental analysis to support an investment thesis. Nothing wrong with that but it doesn't support some the the moves seen in the names mentioned. NMFC is up 10% since the article appeared and this is what was said about it............."New Mountain Finance specializes in lending to companies whose earnings tend to hold up well during downturns in the economy."It was also on a chart of "lower than average risk" BDCs. Ok, fine, but why? I wouldn't buy off this info. FWIW, i own NMFC and seven other BDCs, including ARCC, that comprise 11% of my holdings. The Barron's article doesn't make me feel any better about the sector in any way. Hopefully, no one else will glean anything other than a starting point for further DD from this article.....................................Xot
OK, I find your large BDC position interesting. Is that since 2008? Given Yoda's response, that would seem to be the case.
<<<<Are you sure that today's BDC's could weather another storm like the last one? Since I don't spend any time on BDC's, I do not have a current opinion. I would certainly be suspicious.>>>>I guess that depends on the storm. If it was like the 2008 one , pretty much everything was hammered and beaten down, not just BDC's , so it would be tough to find a place to hide besides government bonds and cash. Junk bonds were yielding in the 20 percent range, high grade bond yields were in the double digits , REIT's were cutting dividends, blue chips were chopped in half or more and many pfds yields were teenagers. Specific to BDC's , they have learned many lessons from the '08-'09 crisis. and many of the larger , stronger ones have diversified their funding sources - both the type (bank lines, straight debt, SBA debt) as well as the maturities of these instruments. That said, in a credit crisis , markets sell first and ask questions later. And BDC's lending money at double digit rates are not lending to worry free credits so your caution is something BDC investors need to keep in mind.
I've owned BDC's since 2008 or so but my current postions date back to early 2011. I run an income portfolio and BDCs are just one of the components, and an important one. Check the link below for an example of a diversified income portfolio with above average yields. BDCs comprise 6.55% of this portfolio by value and are 8.70% of income.https://docs.google.com/spreadsheet/ccc?key=0Ai6nAWjRjzKldDl...Below is linked an informative FAQ on BDCs....................Xot http://www.mofo.com/files/Uploads/Images/FAQ-Business-Develo...
I read the q & a from XOT, but am still confused about the tax treatment on the distributions. It indicates both ordinary and capital gain income. Do you have to wait until year end to determine, similar to some REIT's? Do the different BDC's differ? Are BDC's appropriate for IRA's?Thanks for any clarification,Bill
<<<<Are you sure that today's BDC's could weather another storm like the last one? Since I don't spend any time on BDC's, I do not have a current opinion. I would certainly be suspicious.>>>>Actually, that's a pretty easy question to answer. Just look for the BDCs that did survive the credit crisis and find out why. ARCC, PNNT for a start. If you know about BDCs today, you will know that the ones that survived have taken action to reduce the threats inherent in the credit crisis. For a number of BDCs, the threat was not in the companies they were associated with. The threat was in the nature of their liabilities and the covenants associated with those liabilities. Particularly, bank credit facilities. The market marked down their assets far in excess of the fundamental concerns of the businesses that BDCs loaned to. They broke covenants associated with their credit facilities and the banks moved against them. Not in all cases, but in some.Further, the main issue was how the big boys had developed over time. They had become large equity owners as opposed to lenders. The equity marks were decimated. That held true with ACAS and ALD, but not with ARCC, another large BDC that made it thru the credit crisis (bought out ALD), and is prospering today.I own a number of BDCs. I think they are good income investments, if you follow your companies and the lending market very closely.
If you are an income investor, or rather a compounding investor, then finding good income prospects with a reasonable amount of risk is paramount. I think BDCs are fine investments, if you get it right. You have to do quite a bit of homework to understand your companies and the macro environment.Here is a website that can help http://bdcreporter.com/There is another fellow on Seeking Alpha named Factoids who does stellar work.
>>David's big complaint was that ALD did NOT accurately mark all of their investments to marketmore to the point, there is basically no market in these underlying debt instruments - they mark to "model" in most cases
Comments welcome. I might take a small stake in one of these.I, too, read this story with interest. I don't pretend to understand these companies, but there ARE similarities to M-REITs. I suspect that the key factor that will drive the success (or failure) of these companies is the soundness of their loan underwriting. The BDCs that Barron's mentions favorably seem to have a reasonably good track record in that regard.As always, for investors it's a "risk/reward" issue; we are again reminded of the "no free lunch" principle. Are the 9% yields available on these stocks large enough to offset the obvious risks? Are they better than REIT pfds on a risk/reward basis?Perhaps I am really stupid, but I think the prospects are sufficiently interesting that I have put a small amount of my capital into each of the four BDCs mentioned in the Barron's article, and believe the risk/reward trade-off may be a bit better than the 4.6% yields to first call at which many quality REIT pfds are now trading. But I am not placing a big bet on these. Color me "interested but cautious."Ralph
Further to Yoda's points...there certainly is substantial risk in every BDC, as he shows. I wouldn't put capital into any of these unless I am willing to risk a substantial part of it. As I said, I invested a little bit in each of the four, but will pull the sell trigger if and when they decline by 20%. It wouldn't be pleasant, but I can afford to take such a hit. In the old days, they used to call these stocks "businessman's risks."Ralph
Yodaorange posted what appears to be a consensus type thinking response. It was a good response. But I believe it to be wrong. How?For example, calling ALD and ACAS two of the biggest and best managed BDCs is a statement that I question. They were two of the biggest - but were they the best? No way. And what about the implication that you can judge the full BDC sector based on the experiences of those BDCs? Would it not be equally wrong to judge REITs based on the history of GGP and KIM? GGP eliminated their dividend for several years. KIM cut its dividend from $0.40/quarter in 2008 to $0.25 in 2009 to $0.16 in 2010.For a REIT investor to write that BDC investors are taking high risk is something like the pot calling the kettle black - right?Of the retail REITs that I track [AKR, BFS, CDR, DDR, EPR, EQY, FRT, GTY, IRC, KIM, KRG, O, REG, RPT, WRI, CBL, GGP, MAC, PEI, SPG, TCO] 18 of those 21 cut their dividends. And most of the cuts were greater than 50%. The large majority of BDCs also cut their dividends since 2008. The same could be said of bank stocks.Yodaorange wrote "any investment that is currently paying 8%+ yields today is HIGH RISK."I see all equity investments with a "yield plus dividend CAGR" (CAGR being the acronym for the projected Compound Annual Growth Rate) perspective. I do include risk metrics in my valuation calculations - but for now, let us leave that consideration out. An investment that only offers an 8% "yield plus CAGR" is a terrible investment My goal as an investor in individual stocks is to have a portfolio that is dominated by 11, 12 and higher "yield plus CAGR" investments. There are a lot of sub 1% dividend CAGR projection equities. Not all of those are high risk. For those investments to have near correct valuations, they need to have high yields. It is the perspective that leads me to conclude that the statement "any investment that is currently paying 8%+ yields today is HIGH RISK" is an under nuanced conclusion.I would also argue that the individual retail investor often has huge failings in their ability to quantify risk. And stocks that reside in sectors where the retail investor is the dominant holder of those investments will often have unmerited valuations.I strongly believe that BDCs are an economically sensitive sector - and that brings added risk. I have a self imposed sector allocation to BDCs - and they are currently around 6% of my portfolio. I would be uncomfortable having a higher allocation. So . . . . I am not arguing that all BDCs are safe and investors are almost guaranteed to have happy endings will all their BDC investments. But I did want to provide input to the highest recommended response on this board about BDCs that contained content that was . . in my view . . sub-optimal.
Factoids,I appreciate your willingness to engage in this discussion, but I'm puzzled by some of your wording.An investment that only offers an 8% "yield plus CAGR" is a terrible investment My goal as an investor in individual stocks is to have a portfolio that is dominated by 11, 12 and higher "yield plus CAGR" investments. There are a lot of sub 1% dividend CAGR projection equities. Not all of those are high risk. For those investments to have near correct valuations, they need to have high yields.Can you give us an example of a high yield investment that does not have high risk? It would help me to understand your perception of the terms "high yield" and "high risk".I would also argue that the individual retail investor often has huge failings in their ability to quantify risk. And stocks that reside in sectors where the retail investor is the dominant holder of those investments will often have unmerited valuations.Do you have evidence for these statements?Thanks,Ears
Ears asked "Can you give us an example of a high yield investment that does not have high risk? It would help me to understand your perception of the terms "high yield" and "high risk"?"I hope you know something about MLPs for this answer. The example I would choose is BWP. It is almost a large cap - and definitely midstream. The yield on its 09/15/2019 maturing bond is sub 3%. LTM distribution growth is zero - but the distribution has anemically grown over the past 24 months. The yield on the equity is 7%. So that is close to high yield territory - and a better yield than the average junk bond. The distribution is covered by the DCF/unit. It is low risk - but the yield plus roughly 2% CAGR projection is 9%. One might be able to justify buying it as a junk bond substitute. But that decision would be hard to justify in comparison to other MLPs.Ears asked "Do you have evidence for these statements" [that the individual retail investor often has huge failings in their ability to quantify risk]? Dang near every spreadsheet that I produce shows this. But I was able to generate data on this topic from polling relatively well educated investors who were participants in a poll done in 2012 on the Investor Village MLP board. This can be found at http://www.investorvillage.com/smbd.asp?mb=5028&mn=25347...If that link fails to work:The board can be found at http://www.investorvillage.com/smbd.asp?mb=5028&clear=1&...and the message number is 25347. There is a "Go to Msg #" that is located just above the list of current messages.Sample data from the poll:Question 3 [82 views - 53 votes] I have used debt/market cap and debt/EBITDA data as a tool in choosing/buying a MLP ----------- 18 or 34% Only debt to market cap is important. I'd avoid MLPs when their debt/market cap is out of line -- 8 or 15% I may have seen the data, but I have not really used the data in an investment decision ----------- 27 or 51%In hindsight - I wish I had only polled on the Debt/EBITDA metrics, just to see how low of a percentage of investors use that tool. The poll was conducted on the IV EPD board in June of 2012. Those on the larger generic "MLP" board were invited to participate and given the links to the poll. The specific poll messages have been deleted because the responses were NOT anonymous. The poll was done by counting "recommends" as yes responses to specif questions - and IV identifies the user name for each recommend. The message were deleted to protect the identity of those giving positive responses to negative habits. To some degree, every message board posting is "peer reviewed". And it appears there were no surprises in the findings. If anything, it appeared that the findings created a group yawn - as if any info provided there was totally useless data. I used the data to craft several messages to the UBTI volunteers on the importance of risk quantification in assessing equity stock valuations. Let's see if I can end this with an accurate projection. The number of folks on this board will also give a collective yawn to this message. The number of recommends to this message will be low. The data presented here will generate very little feedback. Ears - thanks for the question. I was happy to respond.
There was a big error in the previous message.I wrote "In hindsight - I wish I had only polled on the Debt/EBITDA metrics, just to see how low of a percentage of investors use that tool."I should have proof read this. I did test on that metric. Sorry about that error.
I won't ever forget DLR-B....since called. Back in the bad days of 2008/2009, this fine pfd from a well respected reit declined as low as $12.50 where it yielded 14%, with a chance for a 100% gain if called. I pounded the table on the income board at IV for the board members to take advantage of this opportunity. One member responded....."Xot, that's no good. Don't you know high yield equals high risk?"Below is a sample from my own holdings. All are high yield but i wouldn't characterize them as "high risk" because of that...................................XotSDRL 8.79% 38.23JPI 7.93% 25.57CLMT 7.18% 37.88LGCY 8.25% 27.89NRF-D 8.45% 25.15DX-B 7.60% 25.09 VNR 8.58% 28.31ARCC 8.42% 18.05NMFC 8.71% 28.28
Factoids, who is infinitely more knowledgable about BDC’s wrote a reply to a post that I did on BDC’s. I have added a few comments:1) For example, calling ALD and ACAS two of the biggest and best managed BDCs is a statement that I question. They were two of the biggest - but were they the best? No way. It is easy for us to say in hindsight that ALD and ACAS were not well managed. That is NOT what I recall before the crash. I recall they were widely praised, other than David Einhorn’s criticism of ALD. Matter of fact, he was “wrong” for many years about ALD. I recall many write-ups about ALD having continuously paid dividends since the 1960’s IIRC. The implication was that if ALD was smoke and mirrors, it would have blown up earlier. I recall many write-ups on how outstanding ACAS CEO Malon Wilkus was. 2) And what about the implication that you can judge the full BDC sector based on the experiences of those BDCs? Would it not be equally wrong to judge REITs based on the history of GGP and KIM? GGP eliminated their dividend for several years. KIM cut its dividend from $0.40/quarter in 2008 to $0.25 in 2009 to $0.16 in 2010.ALD and ACAS were by far the largest market cap BDC’s before the crash. I am working on a more detailed post that will quantify this. I am going to guess they were >= 50% of the entire BDC market cap. So I do NOT think it is unreasonable to judge the entire sector based on the performance of these two, since the majority of BDC investor funds were tied up in these two. ALD lost say 90% and ACAS is down say 75%. When half of the industry has this performance, it is tough for me to ignore. I am not aware of a market cap weighted index that goes back to 2007, but let’s assume it would be down about 50% on a total return basis.Contrast this to the largest market cap REIT’s SPG, HCP,VTR and GGP. Let’s just use VNQ as a proxy for Equity REIT’s since it is market cap weighted. It’s all time high of 87.44 was on February 8, 2007. Its total return to today’s close has been +13.8. So an industry to industry comparison is NOT close. BDC’s lost about 50% and Equity REIT’s gained 13.8%. Yes, many REIT’s cut their dividend. Yes, GGP went bankrupt but re-emerged with stockholders still owning shares, i.e. they were not wiped out. So even if the dividend cuts and GGP bankruptcy, investors still have a positive return.3) I see all equity investments with a "yield plus dividend CAGR" (CAGR being the acronym for the projected Compound Annual Growth Rate) perspective. I do include risk metrics in my valuation calculations - but for now, let us leave that consideration out. An investment that only offers an 8% "yield plus CAGR" is a terrible investment. My goal as an investor in individual stocks is to have a portfolio that is dominated by 11, 12 and higher "yield plus CAGR" investments. There are a lot of sub 1% dividend CAGR projection equities. Not all of those are high risk. For those investments to have near correct valuations, they need to have high yields. It is the perspective that leads me to conclude that the statement "any investment that is currently paying 8%+ yields today is HIGH RISK" is an under nuanced conclusion.I agree with the yield plus dividend CAGR approach. This is the “Gordon Dividend Model” which says that the total return of a stock is its dividend yield plus dividend growth rate. I posted about this a long time ago. The underlying assumption is that the P/E or P/FFO ratio does NOT change. If it does not change, then the model works fine. Let’s talk about the issues that have dividend CAGR’s of <=1.0%. I would consider these “bond proxies” since bond interest payments do not grow over time. So what does it take to get an 8% yielding bond these days, at say 10 years? I just ran a screen with one of my bond brokers. I looked at all corporate bonds that mature in 2023. Late in the day, they had 254 active offerings. The highest rated issues like Coke, Colgate and Berkshire have ~ 2.5% yield to maturity. I currently only see one offering at >=8.0% and that is Borden chemical at 9.91%. It is rated Moody’s Caa2 and SP CCC+. These ratinsg both indicate the rating agencies think default is IMMINENT.So comparing a zero growth 8.0% yielding BDC to the corporate bond universe is my basis for the “high risk” belief. Yes, BDC’s and bonds are not exactly the same, but this tells me that investors have low confidence that the BDC yields will be consistent and/or that the share prices will be flat to up. 4) I strongly believe that BDCs are an economically sensitive sector - and that brings added risk. I have a self imposed sector allocation to BDCs - and they are currently around 6% of my portfolio.I do NOT worry about Factoids losing a bunch of money with his 6% allocation to BDC’s. In the worst case if BDC’s dropped in half, it would not have a material impact on the portfolio. What I DO worry about is other people that invest a higher allocation in BDC’s, strictly based on the high yields. If someone had 60% allocated to BDC’s, I would be very concerned.If we never have another recession or mini-depression, I think BDC’s as a sector will do fine. I suspect but cannot prove that ACAS and ALD would have done fine if the downturn hadn’t flown in. I do NOT understand exactly what damaged ACAS and ALD. I am sure Factoids understands why. The first question I would ask about any current BDC’s is how their business model is different because of the downturn experience of ACAS/ALD. This does not guarantee smooth sailing, but it is a start.It strikes me that BDC’s are similar to CLNY and STWD. All of them rely on paper assets. All of them rely on valuing “obscure”, “one-off” paper where there is no active market. Maybe the better comparison would be BDC’s versus CLNY/STWD.One other point to remember is Yoda’s approach. It is being the most conservative investor around these parts. What is high risk/unacceptable to Yoda might be OK for your particular situation.I was working on a more detailed analysis of BDC’s and will post it when completed. I wanted to go ahead and respond to Factoids excellent points in the meantime.Thanks,Yoda
I will have to leave the in-depth excellent analysis of BDC's to YO, Factoids,and Xot, but, perhaps irrationally, I remain leery of the BDC's as a group simply because of my getting a huge third degree burn with ACAS as my biggest loss by far in the 2008 crisis. The only positive out of this disaster for me was tremendous capital losses to offset my (fortunately)subsequent substantial gains in other areas (I had a come to Jesus decision after the crash and switched my portfolio out of common stocks, both income and growth, and a few BDC's to an entirely fixed income portfolio of diverse preferred stocks in 2008, later adding some CEF's, some muni bond funds; my investments now as I am closer to retirement are all about yield/reliable income). As pointed out by YO, ACAS has yet to restore ANY dividend, yet has spun off subsidiaries that do,, and these entities are well considered by many posters I read (deja vu? -just like ACAS in the pre-crash days ?). Xot's philosophy is close to my financial thinking, with the exception of my aversion to this particular area with an almost conditioned response when BDC's are mentioned-profound sweating and anxiety occurs.
"Xot, that's no good. Don't you know high yield equals high risk?"Is there a correlation between high risk and high yield? Sure, but that doesn't mean high yield is ALWAYS high risk - especially in market panics.In today's environment of everyone seeking what little yield they can, I doubt there are many high yielders with low or moderate risk, whatever the adjectives low or moderate means. The yield on BDC's indicates the investment heard sees them as high risk or somehow unsuitable investments. While not common, sometimes the heard is just wrong. When the heard is wrong such investments can create big gains, but when the heard is right big losses can result.I always like to know how my investments WORK. For a BDC I would want to know the following:1) What is their source of funds to lend? Banks,bonds, etc.,?2) What is their target investment? I mean on one end they are competing against banks (which today have almost free deposits) and on the other end they are competing against venture capital funds. Their borrowers probably are too risky for banks and are culls to the big VC funds. The reason that are culls to the VCs could be that they are just too small for most VC funds or perhaps they are deemed unsuitable in terms of risk/reward.3. How are the managers paid?4. What is their track record? Have they, or their managers, been around long enough to have a track record? If they are any good why aren't they making the big $ at VC funds? Or if they are good, how long until they do make the big $ at some VC fund - and less capable hands are at the held of your BDC investment!My sole experience with a BDC investment was a closed end fund called Equus (EQS) that operates as a VC fund of sorts. There track record is pretty dismal - the only closed-end fund I ever lost money on. They take hedge fund like fees out of the fund, so since I first owned it back in the mid-1990's the management has made a lot of money, the investors not so much. I understand my experience with EQS may have soured me on such investments and throwing out a whole industry based on one bad investment is probably not wise, but I will leave BDC's to others.As an aside, I read Einhorn's book about Allied Capital, or I should say the first half. I had to put it down before I barfed. Mr Einhorn seemed to think that every federal agency should be out there proving him right and that a lender should pull the plug at the first sign of a troubled loan even if that would probably maximize the lender's losses-but Mr. Einhorn's gain! I will point out that Allied Capital only collapsed during the worse economic crises in 70 years and that should such a crisis not occurred he might have been wrong.
Let me put in my 2 cents.I try to invest only in businesses that I think I understand. I invested in REITs because I followed them closely over the years (with the help of this board) I learned about REITs and how they worked. I didn't invest in BDCs because I haven't followed them over the years and don't know how they worked. As far as I'm concerned they may offer a superior reward/risk ratio than REITs, but so may many other sectors. I'll stick mostly with REITS and their preferreds.I don't think that > 8% dividends always always means lots of risk. In the case of LXP, their preferreds once had over 12% yield. I thought the market was wrong because it did not fully appreciate that much of their debt was non-recourse. I made big bucks on their preferreds but was I smart or was I lucky? I don't know but I made bet on the preferreds based on some information that was (I think) not commonly appreciated. There may be lots stuff out their with > 8% yield. But unless I think I know something that the market has not fully appreciated, I'll stay away. I don't know anything ab BDCs so so I'll stay away. Factoids knows lots more than I do about BDCs than I do and may feel they are relatively safe. And he is probably right but I'll stick to what I think I know.Right now I'm trying to diversify. I'm starting with a small position in some of the MLPs and trying to learn about them and hope to slowly build up a sizable position. Maybe I should start with a small position with BDCs and build that up. But for various macro reasons I choose MLPs. I'm also investing in safe stocks that I don't know much about like BRK-B and PG for diversity.Comments, bricks welcomeklee12
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