Seeking Alpha

Russell joins S&P in booting BDCs from indexes; sector slips

  • Unless the SEC changes the sector's fee-reporting standards by May 15, Russell told clients last night it will remove BDCs from its indexes during its June reconstitution.
  • Earlier calling such a move somewhat of a nonevent, Wells' team sounds like it's singing a different tune now. They believe there's a chance the SEC does change the rules, because not doing so would "likely drive sophisticated institutional capital away from the space." More: "We believe this is the very capital that is adept on calling out subpar BDCs. … In our view, a healthy and sophisticated public market is needed to ensure that only those deserving BDCs are the ones to receive the capital."
  • It's no little deal as an estimated 8% of all BDC shares are owned by funds benchmarked to the Russell 2000 index.
  • Index maker CRSP, whose benchmarks are tracked by Vanguard, already bars BDCs, calling them "essentially publicly traded private investment vehicles ... [we] excluded BDCs from the get-go, recognizing that they really don’t represent equity securities of the type that are trying to be captured in equity indexes."
  • In a big green down for the markets, most of the BDC sector is in the red. Prospect (PSEC -0.5%), Fifth Street (FSC -1.5%), Ares(ARCC -0.9%), BlackRock Kelso (BKCC -1.6%), Medley (MCC -0.9%) THL (TCPC -1.6%), NGP (NGPC -2.9%), New Mountain (NMFC -1.6%), PennantPark (PNNT -0.5%), Triangle (TCAP -0.7%).
  • ETFs: BDCL, BDCS, BIZD
Comments (16)
  • Orthoeconomics
    , contributor
    Comments (68) | Send Message
     
    This is total BS. By definition, Berkshire Hathaway is a BDC!
    4 Mar 2014, 03:37 PM Reply Like
  • IndioBravo
    , contributor
    Comments (117) | Send Message
     
    I was not aware that Berkshire Hathaway paid 90% of earnings in dividends.
    4 Mar 2014, 06:17 PM Reply Like
  • NV_GARY
    , contributor
    Comments (3072) | Send Message
     
    Berkshire's not lending $.
    4 Mar 2014, 07:52 PM Reply Like
  • davidlingrfelt
    , contributor
    Comments (8) | Send Message
     
    Yes they have several times Goldman Sacks , General Electric, shall I go on.......................
    7 Mar 2014, 01:27 AM Reply Like
  • CaptTurbo
    , contributor
    Comments (44) | Send Message
     
    They hate private equity in this new swing to Marxism.
    4 Mar 2014, 03:53 PM Reply Like
  • Morgan Myrmo
    , contributor
    Comments (950) | Send Message
     
    Title error, they did not yet boot the BDCs as the first bullet-point stated.
    4 Mar 2014, 03:56 PM Reply Like
  • jfoyst
    , contributor
    Comments (7) | Send Message
     
    Another chance to add to FSC and PSEC. I did add to both. Thank you.
    4 Mar 2014, 05:00 PM Reply Like
  • newnnly
    , contributor
    Comments (253) | Send Message
     
    Added more PSEC today.
    4 Mar 2014, 05:20 PM Reply Like
  • Teriee
    , contributor
    Comments (91) | Send Message
     
    Could it be that the United States of give your money, your house, your first born to the mega banks..of America just doesn't like the success of our beloved BCDs?????
    4 Mar 2014, 05:44 PM Reply Like
  • Brandond
    , contributor
    Comments (391) | Send Message
     
    Good opportunity to buy in May as indexes dump a lot of supply greater than what retail buyers can take up quickly. No reason to buy now for 3 months of dividends when the future price decrease is likely to wipe out any income one would earn between today and May 31.

     

    Great to own in an IRA but entry price going to offer better opportunities.
    4 Mar 2014, 05:53 PM Reply Like
  • clamosaurus
    , contributor
    Comments (115) | Send Message
     
    Brandond: Unless of course the SEC changes its fee reporting requirements, as noted.
    4 Mar 2014, 05:56 PM Reply Like
  • Redeemed
    , contributor
    Comments (6) | Send Message
     
    Look at it this way, PSEC is still paying a dividend of 11 cents plus on a monthly basis through August of this year.
    4 Mar 2014, 05:58 PM Reply Like
  • AcerDave1
    , contributor
    Comment (1) | Send Message
     
    I agree. There seems to be a huge double standard here. So what if BDCs are different. Aren't S&P and Russell reducing their broad diversity by excluding them as a class?

     

    I own and follow PSEC closely. I'm trying to find something positive here. Could there be some better buying opportunities ahead? I still say the underlying business of PSEC and many BDCs is solid, and if you're not afraid of "private investment vehicles," this could be a great opportunity. Perhaps not all BDCs are worthy, but I believe PSEC is. PSEC represents a pool of ~130 (mostly) Investment Grade Bond equivalent investments that average twice the normal yield because the stock is trading below its net asset value with little appreciation of its total return. PSEC is being thrown out with the baby and the bath water. Why would you sell here? What can you do that is better?

     

    It sounds like there will be a couple months of uncertainty that could drive prices down, driving yields higher even though risk is unchanged. In fact, based on previous articles on this site, stock price may be going down at a time when net income is set to rise. PSEC announced it is increasing leverage (.5 to .7 ... BDCs are allowed up to x2, banks x10). This will contribute to more originations and higher net income. Are banks less risky at x10 leverage and <50% dividend payout ratio? I don't think so, especially today.

     

    PSEC's current dividend has a high payout ratio (~100%), but there are ample "banked" earnings to cover any shortage for about 2 years. BDCs must distribute ~100% of earnings to avoid being taxed as a C-Corp, so it is not as alarming for a BDC to be near 100% payout ratio is it is for a bank. BDCs are allowed to keep some "excess" earnings in surplus periods to cover "shortfalls" in leaner periods while maintaining a stable dividend.

     

    There is likely a lack of understanding about BDCs that keeps most BDCs off many investor screens, as it is typically "safer" to avoid dividend stocks with payout ratios approaching or above 100%. Therefore, BDCs will often lag the market as they tend to trade based on NAV and TTM PE. For PSEC, forward earnings are forecast higher. There is an unnaturally high yield because the whole class is out of favor, not because risk is any higher.

     

    2014 looks like it's going to be a turbulent year with broad index gains likely to be small if not negative. Seems like there is an opportunity to put cash to work in something that has a nice yield while waiting for clearer market momentum to return or for BDCs to gain favor. If SEC wises up and changes the rules to allow index funds to include BDCs, the capital gains could be a huge bonus for patient investors. Note: Some specifics above are borrowed from a few very excellent posts about PSEC on this site in the past few days.
    4 Mar 2014, 05:58 PM Reply Like
  • Rick Keane
    , contributor
    Comments (2) | Send Message
     
    Where were all the "buy" analysts as this was brewing. Another blow to income seeking retirees. Maybe the dividends are still there, but this won't bode well for short term net worth. Removing 8-10% of ownership will sorely reduce valuations. Who knows how long it will take to replace. I only hope that the SEC can come to some positive place here. In the meantime it'll be a bumpy ride. Hold on...
    5 Mar 2014, 01:48 AM Reply Like
  • moose60061
    , contributor
    Comments (183) | Send Message
     
    Rick, you bring up a point nobody seems to be able to answer. "who knows how long it will take?".
    my questions are ...........are these funds required to maintain these stocks in their index until the day they are removed? Or can they sell along the way? If not, who would be able to buy all that stock after the final day they are traded? (without the stock getting demolished in the process).
    23 Mar 2014, 03:12 PM Reply Like
  • lmcginnis
    , contributor
    Comments (5) | Send Message
     
    This is good news because of this quote: "Index maker CRSP, whose benchmarks are tracked by Vanguard, already bars BDCs, calling them "essentially publicly traded private investment vehicles ... [we] excluded BDCs from the get-go, recognizing that they really don’t represent equity securities of the type that are trying to be captured in equity indexes." That is exactly why BDCs are good investments in order to allocate away from value stocks and increase income. It does not matter if valuations drop in the short term. Investors don't buy BDCs for gains ... they buy them for income that exceeds bonds and value stocks. If your clients complain about a short term drop in their statement value, then you didn't educate them sufficiently.
    6 Mar 2014, 09:49 AM Reply Like
DJIA (DIA) S&P 500 (SPY)
ETF Hub
ETF Screener: Search and filter by asset class, strategy, theme, performance, yield, and much more
ETF Performance: View ETF performance across key asset classes and investing themes
ETF Investing Guide: Learn how to build and manage a well-diversified, low cost ETF portfolio
ETF Selector: An explanation of how to select and use ETFs