From Contrarian Outlook: Most business development companies (BDCs) have low profiles on Wall Street. Their relative obscurity makes them good vehicles for banking high yields – in fact, today we’ll discuss three that pay between 12% and 16% annually.
BDCs invest in small- and midsize businesses, the building blocks of entrepreneurial America. They were created by the government in the 1980s to help grow up-and-coming companies in a bid to stimulate business and create jobs. They provide debt, equity and other forms of financing to businesses that larger banks and investment firms shy away from.
They’re also income machines by law.
Their regulated structures require them to dole out 90% or more of their taxable income to shareholders in the form of dividends. Their use of debt leverage also helps them juice their profits and payouts (though with borrowed money comes higher risk).
But there are few “free lunches” when it comes to 12%+ yields. So let’s start with two BDC dividend traps.
Prospect Capital (PSEC)
Dividend Yield: 12.3%
Prospect Capital Corporation (PSEC) invests primarily in first- and second-lien secured loans across a wide swath of industries.
Consider some of PSEC’s investments: software firm Blue Coat Systems, water flosser company Waterpik, restaurant supply company TriMark and hospitality payments network operator Onyx CenterSource. Prospect Capital lets you invest in a number of niche companies you simply wouldn’t be able to gain exposure to any other way. And it does so while offering a thick 12%-plus dividend.
But that’s where the fairy tale ends.
Prospect Capital simply has a long history of poor operations. The firm recently reported that fiscal Q3 net investment income declined about 16% year-over-year, sending shares down by double digits in a matter of days. Worse, back in 2015, PSEC cut its monthly dividend to 8.33 cents per share … and hasn’t raised it since.
The headline yield is nice, but everything else should make you think twice.
Prospect Capital (PSEC): That’s It?
Triangle Capital (TCAP)
Dividend Yield: 12.3%
If we’re going to talk about dividend cuts, we also have to talk about Triangle Capital (TCAP), which slashed its dividend from 54 cents to 45 cents around this time last year.
Triangle Capital is similar to PSEC in that it offers expansive industry diversification, investing in consumer products, healthcare, building materials, aerospace, waste management, agricultural and garden products and even nutritional supplements. It typically invests in lower middle market companies through junior capital, both debt and equity.
However, return on equity has plunged in recent years, as have shares, which are off about 40% from their late 2013 peaks. That includes a dip in early May following its most recent earnings report, as the company took a nearly $13 million net realized loss thanks in large part to a write-off of several portfolio companies.
ETRACS 2xLeveraged Long Wells Fargo Business Development Company Index ETN (BDCL)
Dividend Yield: 16.3%
The ETRACS 2xLeveraged Long Wells Fargo Business Development Company Index ETN (BDCL) is an unorthodox twist on the popular ETF concept.
BDCL is an exchange-traded note (ETN), which in short means that instead of actually holding BDCs, it’s a debt instrument that simply tracks the performance of an index, dividends and all. In this case, BDCL does a little something extra. It not only tracks the Wells Fargo Business Development Company Index – an index of about 40 BDCs – but provides 2-times its daily performance and income.
The chart below compares BDCL to the aforementioned TCAP, as well as BDC blue chips Ares Capital (ARCC) and Main Street Capital (MAIN):
BDCL Has Some Serious Total Return Potential
As you can see, on a price-performance level, BDCL looks like a dog. But its dividends are so formidable that it holds up well on a total-return basis over time. And if you catch BDCL in a bull market for BDCs, you can really bank some big gains and payouts quickly.
Think of BDCL as a trading tool, not an investment. Don’t overstay your welcome as a shareholder if you decide to buy – or the double-downside days will eventually catch up with you in a BDC bear market.
The ETRACS 2xLeveraged Long Wells Fargo Business Development Company Index ETN (NYSE:BDCL) was unchanged in premarket trading Friday. Year-to-date, BDCL has gained 2.60%, versus a 8.16% rise in the benchmark S&P 500 index during the same period.
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This article is brought to you courtesy of Contrarian Outlook.