Philip van Doorn

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Oct. 3, 2016, 3:19 p.m. EDT

How to still get 10% dividend yields — if you can stomach the risk

Business development companies can be volatile, but the yields may be worth it if you can hold on for many years

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By Philip van Doorn, MarketWatch


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Singer Sewing Co. is among the dozens of so-called middle-market companies that have borrowed money from Ares Capital Corp., the largest publicly traded business development company by market value.

In May 2015, we reviewed business development companies (BDCs), publicly traded companies that have particularly high dividend yields — some of them higher than 10%. Now that interest rates have (apparently) bottomed out, it’s time to see how they’ve performed, and also to seek out others.

Please see the previous article for a definition of BDCs. In short, they’re regulated investment companies that distribute most of their income as dividends. They generally make loans to small and medium-sized companies, and have been expanding their business in the post-financial-crisis environment, as banks have pulled back from such lending.

And this means BDCs tend to have high dividend yields. In fact, among a list of 50 BDCs prepared by Keefe, Bruyette and Woods, 26 had dividend yields that topped 10% as of Sept. 23, while 41 had yields over 8%.

We are going to share several lists of BDCs that you might consider for dividend income, but first we need to discuss the risks.

Patience is required

The price investors pay to receive the high dividends is volatility. In Keefe, Bruyette and Woods’ list, 49 were publicly traded through 2015, and 42 suffered prices declines for the year.

“In late 2015, the bond market, particularly the high-yield bond market, really started trading down significantly,” said KBW analyst Ryan Lynch, who now covers BDCs for the firm, in an interview. “BDCs are basically portfolios of higher-yielding levered loans and bonds. So if you have a lot of choppiness or a downtrend in high-yield bonds or levered loans, that’s when BDCs will underperform.”

An example of how difficult life can be in an illiquid market was provided by the demise of the Third Avenue Focused Credit, a high-yield bond fund that was forced to close and return investors’ money — or what was left of their money — as the fund sold its assets into a market that didn’t want them.

This two-year chart for the Bloomberg Barclays U.S. Corporate High-Yield Index shows just how much price volatility we’re talking about:


FactSet

So you’ll need to be able to wait out downturns to (hopefully) continue receiving the dividends through thick and thin.

How our first list performed

In the previous BDC article in May 2015, we listed seven BDCs that were rated “outperform” by KBW analyst Troy Ward — who covered the industry for the firm at that time — along with Goldman Sachs BDC, which was relatively new. Here’s how the group has performed since May 13, 2015:

Business development company Ticker Dividend yield - Sept. 23, 2016 Price change - May 13, 2015 - Sept. 23, 2016 Total return - May 13, 2015 - Sept. 23, 2016 Growth of book value per share - 12 months
Apollo Investment Corp. /zigman2/quotes/205631771/composite AINV 10.24% -24% -8% -14%
Harvest Capital Credit Corp. /zigman2/quotes/206664803/composite HCAP 11.09% -8% 7% -5%
Alcentra Capital Corp. /zigman2/quotes/206623190/composite ABDC 10.36% -4% 10% -6%
Triangle Capital Corp.   9.26% -15% -1% -4%
TCP Capital Corp. /zigman2/quotes/201713855/composite TCPC 8.80% 4% 20% -2%
BlackRock Capital Investment Corp. /zigman2/quotes/203610923/composite BKCC 10.10% -11% 2% -14%
American Capital Senior Floating Ltd. 10.67% -18% -4% -14%
Goldman Sachs BDC Inc. /zigman2/quotes/206963887/composite GSBD 8.21% 5% 17% -5%
Sources: KBW, FactSet

Total return figures reflect the reinvestment of dividends. Then again, since BDCs are income vehicles, you probably wouldn’t be reinvesting the dividends. But you can see the effect of price volatility during a relatively short period for this type of investment. Ideally, you will choose BDCs with excellent underwriting, which means very low credit losses. Leaving aside the share-price fluctuation, you don’t want to see your book value declining very much as you receive the dividend income.

“My opinion is if a BDC pays a 10% dividend, but their book value falls by 5%, I didn’t really get a 10% return. I got a 5% return that year,” Lynch said.

He said that, since credit quality had been unusually solid for several years leading into 2015, credit deterioration over the past year and a half is partially “driven by a normalization of credit,” and partly driven by the decline in energy prices.

/zigman2/quotes/205631771/composite
US : U.S.: Nasdaq
$ 16.33
-0.09 -0.55%
Volume: 415,891
Nov. 13, 2019 4:00p
loading...
/zigman2/quotes/206664803/composite
US : U.S.: Nasdaq
$ 9.05
+0.10 +1.12%
Volume: 5,809
Nov. 13, 2019 3:57p
loading...
/zigman2/quotes/206623190/composite
US : U.S.: Nasdaq
$ 9.00
-0.02 -0.22%
Volume: 26,254
Nov. 13, 2019 4:00p
P/E Ratio
16.68
Dividend Yield
8.00%
Market Cap
$115.76 million
Rev. per Employee
N/A
loading...
/zigman2/quotes/201713855/composite
US : U.S.: Nasdaq
$ 14.26
-0.09 -0.63%
Volume: 147,707
Nov. 13, 2019 4:00p
P/E Ratio
27.29
Dividend Yield
10.10%
Market Cap
$837.42 million
Rev. per Employee
N/A
loading...
/zigman2/quotes/203610923/composite
US : U.S.: Nasdaq
$ 4.97
-0.02 -0.40%
Volume: 230,881
Nov. 13, 2019 4:00p
P/E Ratio
N/A
Dividend Yield
11.27%
Market Cap
$340.74 million
Rev. per Employee
$2,546
loading...
/zigman2/quotes/206963887/composite
US : U.S.: NYSE
$ 20.31
-0.07 -0.34%
Volume: 94,063
Nov. 13, 2019 6:30p
P/E Ratio
31.50
Dividend Yield
8.86%
Market Cap
$814.20 million
Rev. per Employee
N/A
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