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Summary

  • Investors seeking high yields with diversification may want to consider BDCL.
  • BDCL is highly correlated to the overall market, but may be a very good diversifier for investors seeking high income who are now heavily invested in interest rate sensitive instruments.
  • My projection of the upcoming July quarterly dividend for BDCL calls for a decline from prior quarters, but still results in an annualized compounded yield of 17%.

ETRACS 2xLeveraged Long Wells Fargo Business Development Company Index ETN (NYSEARCA:BDCL) is another exchanged traded note that employs 2X leverage to generate exceptionally high yields. It has existed for about three years which allows us to run a regression of weekly returns on it vs. a proxy for the entire equity market such as SPDR S&P 500 Trust ETF (NYSEARCA:SPY) from May 2011 to now. This indicates that BDCL is relatively highly correlated to the equity market, with 72% of the variation in BDCL explained by variation in SPY. Also, as might be expected with 2X leverage, the beta or coefficient that reflects the degree to which BDCL reacts to changes in the overall market is 1.9. This indicates that if SPY were to change by 1.0% it would be expected that BDCL would change by 1.9% in the same direction.

The relatively high yield and high beta or systematic risk is consistent with the Capital Asset Pricing Model. One wrinkle is that for investors seeking higher yields, BDCL may actually be a relative efficient diversifier if those investors are now heavily invested in higher yielding instruments that are very interest rate sensitive.

Previously, I pointed out in: 17.8%-Yielding CEFL - Diversification On Top Of Diversification, Or Fees On Top Of Fees? those investors who have significant portions of their portfolios in mREITs and in particular a leveraged basket of mREITs such as ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN (NYSEARCA:MORL) could benefit from diversifying into an instrument that was highly correlated to SPY.

UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA:CEFL) is highly correlated to SPY while only 5% of the variation in daily returns for MORL can be explained by the daily variation in the S&P index. Since CEFL yields almost as much as MORL, this suggests that a portfolio consisting of both MORL and CEFL would have almost as much yield as a portfolio with only MORL, but considerably less risk. Adding BCDL to such as portfolio could result in a more efficient risk/return profile. Even with the decline in the upcoming BDCL dividend that I project, BDCL would still be yielding 17% on an annualized basis.

CEFL has not been in existence long enough to run meaningful weekly return regressions vs. BCDL. However, YieldShares High Income ETF (NYSEARCA:YYY) is the unlevered ETF version of CEFL and thus has the same portfolio of closed-end funds in the same proportion of each. Thus, a regression using YYY and BCDL should show the same relationship in terms of explanatory power as would a regression using CEFL and BDCL. Such a regression of weekly returns indicate that only 32% of the variation in BCDL can be explained by variation in YYY (or CEFL).

This result makes sense, since the CEFL consists of only closed-end funds while BCDL consists of only Business Development Companies. All leveraged ETNs have interest-rate risk since their dividends fluctuate inversely with the borrowing costs implicit in their leveraged structure. However, MORL has much greater exposure to interest rates than CEFL, and CEFL has somewhat more interest rate risk than BDCL.

Unlike MORL and CEFL which pay monthly dividends, BDCL pays quarterly. As can be seen in the table below, of the 25 Business Development Companies that comprise the index upon which BCDL is based, 7 pay dividends quarterly, 15 pay dividends monthly, one pays dividends semiannually and two do not currently pay any dividends. Interestingly, the largest component of the index upon which BCDL is based, American Capital Ltd (NASDAQ:ACAS) with a weight of 10.25% is one the two components that do not currently pay any dividends.

The Index is a float-adjusted, capitalization-weighted Index, that includes the business development companies listed on the major exchanges. The fact that 13.18% of the companies that comprise BDCL are not currently paying dividends can be looked at with either a "glass is half full" or "glass half empty" perspective. On the bright side, there could be considered room for an increase in the dividends paid by BCDL if those components not presently paying dividends were to resume them. On the other hand, the fact that 13.18% of the companies that comprise BDCL are not currently paying dividends could be seen as warning that other components in the portfolio might also suspend dividends in the future.

The 25 Business Development Companies that comprise the index upon which BCDL is based are a varied lot. Medallion Financial (NASDAQ:TAXI) finances taxi cab companies. ACAS manages $20 billion worth of assets, including American Capital Agency Corp. (NASDAQ:AGNC) and American Capital Mortgage Investment (NASDAQ:MTGE) which are mREITs that are included in MORL.

While each of the 25 Business Development Companies that comprise the index upon which BCDL is based have their own specific risk factors. The power of diversification can make a portfolio now comprised mainly of high yielding interest-rate sensitive instruments more efficient when BDCL is added to that portfolio.

As I explained in the article 30% Yielding MORL, MORT And The mREITs: A Real World Application And Test Of Modern Portfolio Theory, a security or a portfolio of securities is more efficient than another asset if it has a higher expected return than the other asset but no more risk, or has the same expected return but less risk.

Portfolios of assets will generally be more efficient than individual assets. Compare investing all of your money in one security that had an expected return of 10% with some level of risk, to a portfolio comprised of 20 securities each with an expected return of 10% with same level of risk as the single security. The portfolio would provide the exact same expected return of 10% but with less risk than the individual security. Thus, the portfolio is more efficient than any of the individual assets in the portfolio.

The table below shows the components of BDCL along with the price, weight, ex-dividend date and pay date for each. From this data I calculated a projection for the next quarterly dividend of BCDL to be $0.9715. Two of the components: Pennant Park Investment Corp (NASDAQ:PNNT) and NGP Capital Resources Co (NASDAQ:NGPC) have not yet declared their quarterly dividends which will be included in the July 2014 BCDL dividend. However, both of those have paid the same quarterly dividends for a number a quarters. Thus, using the same dividend that they paid in the previous quarters is a good assumption.

My projection of $0.9715 would be a decline of 7.6% from the previous quarter and 7.3% from the year ago July quarter. It would make the trailing twelve month dividend equal to $4.10. This would be a 16% simple yield with BDCL priced at $25.66 and an annualized quarterly compounded yield of 17%.

If someone thought that over the next five years market and credit conditions would remain relatively stable and thus BDCL would continue to yield 17% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $218,911 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $17,100 first year annual rate to $37,215 annually.

25-May-14

BDCL

Price

weight

ex-div

pay date

dividend

freq

ACAS

American Capital Ltd

$14.73

10.25%

none

ARCC

Ares Capital Corp

$17.06

10.17%

6/12/2014

6/30/2014

0.3800

q

SUNS

Solar Senior Capital Ltd

$17.36

9.85%

5/20/2014

5/30/2014

0.1175

m

AINV

Apollo Investment Corp

$8.28

9.28%

6/18/2014

7/7/2014

0.2000

q

FSC

Fifth Street Finance Corp

$9.33

6.47%

8/13/2014

8/29/2014

0.0833

m

TAXI

Medallion Financial Corp

$13.33

6.30%

5/14/2014

5/23/2014

0.2400

q

BKCC

Blackrock Kelso Capital Corp

$8.72

5.48%

6/16/2014

7/2/2014

0.2100

q

SLRC

Solar Capital Ltd

$21.07

4.51%

6/17/2014

7/1/2014

0.4000

q

HTGC

Hercules Technology Growth Capital Inc

$14.77

3.96%

5/8/2014

5/19/2014

0.3100

q

MCC

Medley Capital Corp

$12.43

3.90%

5/23/2014

6/13/2014

0.3700

q

MCGC

MCG Capital Corp

$3.45

3.16%

5/7/2014

5/30/2014

0.0700

q

TINY

Harris and Harris Group Inc

$3.35

2.93%

none

TICC

TICC Capital Corp

$9.63

2.83%

6/12/2014

6/30/2014

0.2900

q

CSWC

Capital Southwest Corp

$35.29

2.69%

5/13/2014

5/30/2014

0.1

semi

PNNT

PennantPark Investment Corp

$11.02

2.66%

3/18/2014

4/1/2014

0.2800

q

GLAD

Gladstone Capital Corp

$9.78

1.95%

6/17/2014

6/30/2014

0.07

m

GBDC

Golub Capital BDC Inc

$16.77

1.63%

6/12/2014

6/27/2014

0.3200

q

PSEC

Prospect Capital Corp

$10.10

1.60%

5/28/2014

6/19/2014

0.1106

m

GAIN

Gladstone Investment Corp

$7.79

1.57%

6/17/2014

6/30/2014

0.06

m

MVC

MVC Capital Inc

$12.83

1.51%

4/22/2014

4/30/2014

0.135

q

TCRD

THL Credit Inc

$13.49

1.34%

6/12/2014

6/30/2014

0.34

q

TCAP

Triangle Capital Corp

$25.70

1.28%

6/9/2014

6/25/2014

0.5400

q

NGPC

NGP Capital Resources Co

$6.39

1.25%

3/27/2014

4/7/2014

0.1600

q

MAIN

Main Street Capital Corp

$31.37

1.23%

8/18/2014

9/15/2014

0.1650

m

HRZN

Horizon Technology Finance Corp

$13.84

1.18%

8/15/2014

9/15/2014

0.1150

m

Source: BDCL: The Third Leg Of The High-Yielding Leveraged ETN Stool

Additional disclosure: I may initiate a long position in BDCL over the next 72 hours.