By Philip van Doorn, MarketWatch
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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:
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.||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.