Back on February 24th, Wells Fargo announced the launch of the "Wells Fargo Business Development Company Index, a rules-based index measuring the performance of certain NYSE and NASDAQ listed Business Development Companies." The press release claims the Index is the first in the industry comprised "exclusively of BDCs."
We were curious about the composition of the Index, and undertook some further digging. That's not as easy as you might expect, as the Index is not widely available. If you have a Bloomberg Terminal (who doesn't ?) you can type in the symbol WFBDC and get the latest price. We also used the same symbol on Yahoo Finance (a much more democratic source of financial information, which means free) and were able to pull up the price and a recent stock chart. There's no background info, though, on the site and very little historical data, so in terms of everyday usefulness it's not so good.
However, we have been able to determine that the Index is composed of 26 BDCs, each with different weightings (i.e. not equally weighted). Wells Fargo has a minimum market capitalization cut-off of $100,000,000 for inclusion. Note, too, that the Index is "float adjusted," which essentially means that Wells Fargo has not included certain BDCs that trade very thinly, but the cut-off is not spelled out. The Index is the brainchild of the Wells Fargo Securities Index Group and the NYSE calculates the value.
Here are a few key stats: The market cap of the BDC Index was just under $18bn, which averages out at around $700,000,000 market cap per BDC included. The yield was 7.8%, and the price to earnings 16.7x. (Earnings here are defined as Net Investment Income and not earnings that include changes in realized and unrealized portfolio values, which swing back and forth and are not useful in our mind).
MEDIUM TERM PERFORMANCE
Wells Fargo has performance data for the Index back to 2005, which is commendable and fascinating. As you'd expect, the Index was up in 2005 and 2006, but began slipping in 2007 (early signs of the oncoming recession ?). Then in 2008 and 2009 the Index dropped (13.6%) and (45.8%) respectively. No surprise there. However, the Index was up the following two years by huge margins. In 2009 the Index was up by 36.6% and in 2010 by 51% (the biggest yearly move ever-up or down). Through the first quarter of this year, the Index was up 8.3%.
WHO'S IN AND WHO'S OUT ?
We looked at whom Wells Fargo has included in the Index. Most of the usual suspects are there: Ares Capital (ARCC), American Capital (ACAS) and Apollo Investment (AINV) (weighted 10% each, and thus one third of the total weighting). Then there's perpetual equity raiser and market darling Prospect Capital (PSEC), Fifth Street Finance (FSC) (which has been growing fast), BlackRock Kelso (BKCC), the relative newbie Solar Capital (SLRC), Pennant Park Investment (PNNT), BDC old-timer MCG Capital (MCGC) and tech specialist TICC Capital (TICC), to round out the top ten names in the list. They represent 70% of the weighting and the next 16 names just 30%.
DIVIDEND ? WHAT DIVIDEND ?
Included amongst the smaller BDCs are at least 3 companies whose strategic emphasis is upon improving shareholder value by investing principally in the equity of private companies and which pay only a modest dividend, if at all. These are Capital Southwest Corp. (CSWC), MVC Capital (MVC), Harris and Harris Group (TINY). For what it's worth, the BDC Reporter does not track the last two names because they are not principally dividend-focused, and we are mulling what to do about MVC Capital.
NOT ON THE GUEST LIST
So who's missing ? Saratoga Investment, which was previously GSC Investment, is not on the list. Likewise, new senior lending BDC Full Circle Financial (FULL) is missing. That's because they don't meet Wells Fargo's minimum market capitalization requirements to be listed. Kayne Anderson Energy (KED), which gave up its BDC status recently to avoid diversification of asset rules and to take advantage of its NOLs, is not on the list, but that company continues to pay a regular dividend and behaves and reports like it did before the legal switch. Less controversial is the omission of Compass Diversified (CODI) (which the BDC Reporter tracks) because it's a Grantor Trust and more a conglomerate than a finance company.
The two recent additions to the BDC space are also not included: Solar Senior Capital (SUNS) and Pennant Park Floating Rate Capital (PFLT), because they are below the minimum capitalization cut-off for the Index. The BDC Reporter itself is just only beginning to adding coverage of these interesting new senior floating rate debt oriented BDCs, which are the flavor of the moment. Then there are several new BDCs in formation waiting in the wings, which will probably swell the ranks of the Index before long.
THE BOTTOM LINE
Is the new Wells Fargo BDC Index useful? We're going to say it depends on who you are and what your goals are. For the individual investor this is not an Exchange Traded Fund ("ETF") that can be traded and give you exposure to the sector. (We were told recently by an informed source that the industry still does not have sufficient diversity and liquidity to allow an ETF to be launched using the BDC industry names alone. Still, we wouldn't be surprised if that continues much longer given the ongoing expansion of the industry, both in number of companies and equity float).
We should also explain how the portfolio weightings work. Ares Capital has a market capitalization five times higher than that of BlackRock Kelso. Yet the respective weightings in the Index are 10% and 6%. That's because Wells Fargo has chosen to cap the weighting of the 3 largest BDCs at 10% of the total. Right or wrong ? That's in the eye of the beholder.
We should also point out that there are actually two indices, one which includes reinvestment of dividends and one which only tracks the change in stock prices. That's not a small item. An investor seeking to compare the performance of the BDC Industry to another sector that does not pay out much in the way of distributions is going to get a flawed picture by looking at stock price movements alone. We undertook an analysis a few months ago of 24 BDCs in existence at the time. We added up their stock prices at the time of their IPOs. Then we compared the total amount of dividends received over their entire history (through the end of 2010). We discovered that dividends received, on average, equaled 32% of the original IPO investment. For BDCs that had been paying dividends for 5 years or more (the industry veterans) the dividends received as a percentage of the original IPO investment was a whopping 58%. The lesson of the day: dividends matter when evaluating the long-term performance of BDCs, not just stock prices.
To get back to our original point, Wells Fargo offers two indices: the previously mentioned WFBDC which is a total return index (dividends reinvested) and WFBDCPX, which is a price return index (excludes dividends).
In conclusion, we offer up kudos to Wells Fargo for getting the ball rolling in the BDC space. Compared to the REIT sector or even energy Master Limited Partnerships, this is a new industry, and deserves a viable and democratic Index (or two in this case) that can serve as shorthand for the industry's performance. We hope Wells Fargo will continue to refine what they've started, and make as available as the market will allow.
Disclosure: I am long ARCC, AINV, ACAS, BKCC, CODI, FSC, PNNT, SAR, MCGC.