Seeking Alpha

BDCs Have Been Crushing The S&P 500 In 2016

by: BDC Buzz

The average BDC has had total returns of over 15% in 2016 compared to the S&P 500 closer to 5%.

However, we are starting to see a pullback in higher risk BDCs as predicted in my previous article.

I am now expecting average BDC total returns closer to 20% for 2016.

The average business development company ("BDC") has had total returns of over 15% in 2016 compared to the S&P 500 closer to 5%. Total return includes stock appreciation and dividends paid. BDCs currently have an average dividend yield of around 11% and I am now expecting average total returns closer to 20% for 2016. See table at the end of this article for total returns for each BDC.

In my September 11, 2016, article "Are High-Yield Retail Investors Starting To Take Profits?" I mentioned:

"I firmly believe that certain BDCs are currently overvalued and there will be increased bifurcation in BDC pricing for the reasons discussed at the end of the article."

"Ideally, investors should be selling higher risk BDCs that have rallied this year, but will likely be suffering from lower portfolio yields, dividend coverage and/or increased non-accruals and declining NAV and using the proceeds to buy higher quality BDCs, especially during increased volatility in the general markets."

"BDCs that are "reaching for yield" to cover dividends will likely invest in higher risk assets with increased non-accruals and declining NAV per share that could ultimately lead to dividend reductions and lower share prices. Most of these BDCs are currently overpriced and will likely underperform the others due to increased risk of upcoming dividend cuts and NAV declines."

"BDCs will likely follow the general markets, but I still believe many of them will outperform even in a pullback/correction environment. This is because there will still be a need for yield even if the Fed raises rates. It seems like we are in a perpetual "lower for longer" with rates likely to remain low for a very long time. BDCs are volatile and the timing of purchases can be critical when trying to maximize yield."

The following table shows the change in stock price for the BDCs discussed in the above linked article:

Best performing BDCs

As mentioned in the previous article, there continues to be a flight to safety with BDCs that have higher amounts of "true" first-lien assets and NAV per share stability outperforming the others including Solar Senior Capital (NASDAQ:SUNS), Golub Capital BDC (NASDAQ:GBDC), New Mountain Finance (NYSE:NMFC), PennantPark Floating Rate Capital (NASDAQ:PFLT), Goldman Sachs BDC (NYSE:GSBD), TCP Capital (NASDAQ:TCPC), FS Investment Corp. (NYSE:FSIC-OLD), Main Street Capital (NYSE:MAIN), Hercules Capital (NASDAQ:HTGC), TriplePoint Venture Growth (NYSE:TPVG), and TPG Specialty Lending (NYSE:TSLX). Triangle Capital (NYSE:TCAP-OLD) has lower-than-average amounts of first-lien assets but better-than-average NAV stability as well as management with a history "doing the right thing" and BlackRock Capital Investment (NASDAQ:BKCC) has been focused on portfolio maintenance and rotating into more income producing assets.

Solar Capital (NASDAQ:SLRC) was an outlier in the previous article and is now outperforming the average.

Worst performing BDCs

Also discussed in the previous article, BDCs that are higher risk and/or with lower amounts of longer-term institutional shareholders will likely decline the most. This includes KCAP Financial (KCAP), Prospect Capital (NASDAQ:PSEC), Fifth Street Finance (FSC), Medley Capital (NYSE:MCC), Gladstone Capital (NASDAQ:GLAD), PennantPark Investment (NASDAQ:PNNT), and TICC Capital (TICC).

Here are some of my predictions from earlier this year that hit the mark so far:

In my January 13, 2016, article "Is This a Buying Opportunity for BDCs" I mentioned:

"Investors should either be buying now or waiting to see if BDCs continue lower with the overall market."

"I am predicting a BDC rally in late Q1 2016 and overall average returns of 17% in 2016."

In my January 18, 2016, article "Fear & Greed for BDCs" I mentioned:

"This should be seen as ridiculous and an opportunity for investors as even a worst case scenario is already priced in for many of these companies."

"I am predicting a BDC rally in February, as companies begin to report Q4 results."

"As mentioned in my "January Newsletter", I closely watch the S&P 500 Volatility Index (VIX) and usually only make BDC purchases when it is above 20. It is currently well above this level and I have been starting to purchase additional shares of select BDCs."

"In my opinion, BDCs are oversold for many reasons and were already trading at healthy discounts before the recent general market downturn. There is a good chance that the Fed will delay further rate increases and investors will be looking for yield as well as undervalued sectors that have a better chance of outperforming the S&P 500. Additionally, I believe that when BDCs report results in two weeks, many of them will beat earnings estimates and have strong dividend coverage. This could result in a rally for BDC pricing."

In my January 23, 2016, article "BDC Buzz Begins 2016 Purchases" I mentioned:

"I have been actively purchasing select BDCs."

"BDCs will begin to report Q4 results in less than two weeks that could drive an upcoming rally."

"Novice and uniformed investors usually make the typical mistake of buying BDCs with lower relative multiples and higher relative yields."

"Investors and fellow contributors need to understand that we have been and will continue to see bifurcation between higher and lower quality companies. This means that they are valued on overall quality as compared to opaque and sometimes volatile NAV values."

"I believe that when BDCs report results in less than two weeks, many of them will beat or match earnings estimates with strong or adequate dividend coverage."

"BDCs that have carefully built their portfolios and balance sheets, to withstand various credit and economic cycles, will likely do much better during rising default and/or interest rates. Many of these BDCs are inappropriately priced which is why I believe we will see higher valuations for companies that are less likely to experience upcoming credit issues that could drive NAV declines and dividend coverage issues in 2016."

In my February 10, 2016, article "Are BDCs at Another Buying Point" I mentioned:

"Bifurcation has increased since my last update with many of the lower quality BDCs in steep declines."

"BDCs have had a rough start to 2016 but so has the general market and there are now 10 companies outperforming the S&P 500 as compared to only 3 in my previous update. I am expecting more BDCs to join the outperforming group this year."

"Poorly managed BDCs such as FSC, FSFR, MCC, PSEC, KCAP and TICC are continual underperformers for this year and longer term. Many of these BDCs have had larger than average declines in NAV per share as well as dividend cuts or coverage issues. More importantly was the lack of share repurchases for PSEC, FSC and MCC during the calendar Q4 2015 and YTD 2016 periods. This should be seen as a fundamental issue with management of not doing the right thing and will likely continue as these companies have not received the message from investors that they are disappointed with how these companies are being managed implied with a stock price trading at a 40% or larger discount to NAV. I firmly suggest that investors sell on rallies for these BDCs if meaningful amounts of share repurchase do not materialize in calendar Q1 2016. Again, AINV is a great example of a management team taking their fiduciary responsibility seriously and fully utilized their old repurchase program and then adopted a new program that they have already started to use."

"As predicted in 'FSC: When to Sell?', the price of FSC crested at $6 and then continued back down. This is definitely a "sell the rally" BDC with plenty of downside without an investor activist."

For more information on BDCs that are likely to outperform in the coming quarters as well as BDC rankings (risk, return, pricing, dividend potential), dividend coverage tiers, fee structures, historical total returns, charts and valuations, interest rate discussion, my historical purchases and current positions, and suggested BDC portfolios, please see "Index to Free BDC Research."

BDC Total Returns for 2016:

Explanation of total returns: The 'Change in Price' assumes you purchased the stock at the end of 2015 and dividends do not assume reinvestment and are calculated using the amounts paid/accrued divided by the purchase price.

It is important to look at returns over a longer period because some of the top performing BDCs this year were the worst performers in 2015 including PNNT and Apollo Investment (OTC:AINV), mostly because they were beaten down due to higher oil-related exposure. BDCs with stronger portfolios and are outperforming including Monroe Capital (NASDAQ:MRCC) as discussed in "Higher Quality BDCs: MRCC".

FSC and MCC are continually the worst performers due to continued credit issues, TCAP recently cut its dividend, BKCC is having issues with legacy investments and Newtek Business Services (NASDAQ:NEWT) has an erratic dividend policy due to the nature of its business model.

In my upcoming articles, I will discuss total returns for longer periods.

Personal note: I have updated my positions to reflect changes in my holdings, but please keep in mind that some of the positions are VERY small and mostly for research purposes.

Disclosure: I am/we are long ABDC, AINV, ARCC, BKCC, FDUS, FSC, FSFR, FSIC, GAIN, GARS, GBDC, GLAD, GSBD, HCAP, HTGC, MAIN, MCC, MRCC, NMFC, PFLT, PNNT, PSEC, SLRC, SUNS, TCAP, TCPC, TPVG, TSLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.