This is an excerpt from a blog published earlier today: Bought 100 MCQPF at $3.632-Lottery Ticket Basket/Sold 100 PWCDF at $28.07/Bought 40 BDCL at $23.53-Flyer's Basket
I am making more purchases pursuant to the Flyer's Basket Strategy (and the Lottery Ticket Basket Strategy), since I am concerned about the stock market's current valuation level. Consequently, I am buying several small positions in securities that have already declined over 10% in price. The Exchange Traded Note described below traded at over $30 last February: BDCL Interactive Stock Chart
Bought 40 BDCL at $23.53 ($500 to $1,000 Flyer's Basket Strategy With Snapshots of Round Trip Trades)(see Disclaimer): I am surprised that I even nibbled on this security. BDCL combines several items that I do not like in one security: an ETN that uses leverage to track an index of BDCs. My stomach just became queasy just writing those words all at once.
Snapshot of Trade:
This is a trade. I bought near the close using a limit order.
Prior Trades: None
Security Description: The 2xLeveraged Linked to Wells Fargo BDC Index ETN (NYSEARCA:BDCL) is an unsecured debt obligation issued by UBS that provides a monthly compounded two times leveraged long exposure to the Wells Fargo BDC Index. That index is a float adjusted, capitalization-weighted index of all NYSE and Nasdaq listed BDCs that have a market capitalization of at least $100 million at the time of inclusion in the index.
This security is an exchange traded senior and unsecured note, otherwise known as an ETN. The owner is exposed to the credit risk of UBS: UBS AG Stock Price; Last SEC Filed UBS Annual Report 20-F. UBS senior unsecured debt is currently rated A2 by Moody's and A by Fitch according to FINRA. The fact sheet shows the UBS AG credit ratings at A2 (Moody's), A (S & P) and A (Fitch), as of 11/30/13. Factsheet BDCL.pdf
On the day of my purchase, I took a snapshot of the index components that had a greater than 1% weighting in this index:
I have relatively small positions in PSEC, ARCC, AINV, FSC, PNNT, BKCC, TICC and KCAP. I will trade those positions under clearly defined rules, where I will at least make an effort to realize a total return greater than the dividend yield at my total cost per share. That goal is far easier said than done. The general rules applicable to externally managed BDCs are to consider buying when the market price falls below the net asset value per share and to consider selling when the market price exceeds NAV per share by 5%.
I will make exceptions to those general guidelines.
I will now consider selling PSEC shares when and if the market price approaches NAV per share. I require now a greater than 10% discount before I will even consider buying more PSEC or TICC shares. And, I am at my limit with 100 shares of KCAP. Bought 100 KCAP at $7.54 (11/1/14 Post)
My disdain for BDCs is well known among blog readers, and I have repeatedly made my opinions on them plain at SeekingAlpha in comments and posts. Added 50 AINV At $7.94 - South Gent | Seeking Alpha; Bought 50 ARCC At $15.41-A Typical Small Lot Purchase Of An Externally Managed BDC Stock - South Gent | Seeking Alpha; New Mountain Finance Share Offering Today Illustrates Multiple Risks Inherent In BDC Stocks - South Gent | Seeking Alpha
This ETN is discussed in a Seeking Alpha published last September.
Dividends: This ETN has been paying a variable quarterly distribution. BDCL Dividend History-NASDAQ.com The four quarterly dividends paid in 2014 total $4.1373 per share. At that rate, the dividend yield would be about 17.58% at a total cost of $23.53 per share.
The 2013 and 2012 dividend payments amounted to $4.0659 and $3.3596 per share respectively. ETRACS
Rationale and Risks: The main reason for buying this type of security is to harvest one or more dividends and then escape with a profit. If BDCs do improve in price over the coming weeks or months, then I have a cushion to hold onto BDCL longer and to harvest more than one dividend. The best possible outcome from my perspective, as a conservative investor, would be to harvest 4 dividends and to escape with a profit selling the shares.
This is a trade, not a long term investment for me.
This trade is partly based on the fact that the share prices of several BDCs have declined significantly this year, creating larger than normal discounts to net asset values per share for several externally managed ones.
The price downtrend has occurred with interest rates declining, which makes the BDC yields more attractive compared to alternative income investments particularly junk bonds.
The following list is a sample of the current discounts to net asset value per share, based on last Friday's closing price and the last reported net asset value per share made in a 10-Q or 10-K filing:
Closing Market Price 11/21/14/Net Asset Value Per Share as of 9/30/14 (Except for FSC which is as of 6/30/14)/Discount (rounded)
All of the foregoing BDCs are externally managed.
BDCs, particularly the externally managed ones, have been beaten up this year. One reason may be related to being kicked out of the S & P and Russell indexes earlier in the year.
Investors may have also soured on several of them due to persistent share offerings. Persistent weakness in share price can be self-sustaining even when it makes no sense at a certain price level.
Last Friday, for example, the price of TCPC was knocked down 4.12% after that BDC launched a share offering, Pricing Sheet. That BDC has an ATM offering prospectus outstanding for up to $100M, Prospectus TCPC had another large offering back in July 2014, Prospectus, priced to the public at $17.3. Yet another offering was made in December 2013, Prospectus. At least the public offering price in those sales was above TCPC's net asset value per share.
Tax loss selling may also be coming into play just looking at some one year charts:
I am hoping that these stock will receive a bounce during the 2015 first quarter, as some of the selling pressure subsides. For externally managed BDCs, it would be most helpful simply for their market prices to converge to their respective net asset values per share. Maybe some of the worst offenders could actually increase their net asset value per share for a few quarters.
The discounts to net asset values has expanded significantly for several of them, including FSC, PSEC, and TICC.
Sponsor Summary of Risks is Very Long:
The prospectus can be downloaded from the sponsor's website. A summary of the risks starts at page S-20 and ends at page S-31. The sponsor also summarizes risks at its website under the "key considerations" tab.
I view this security as extremely risky which explains why I place it under the restrictions of the Flyer's Basket Strategy.
BDCL does incur short term borrowing cost. A rise in the 3 month Libor rate, which will happen when the FED starts to raise the federal funds rate, will increase the borrowing costs and negatively impact the total return.
Leverage works both ways. If BDCL successfully goes up twice the value of the index after fees and expenses, it will also go down twice the value of the index's decline.
The decline in the BDC sector has caused BDCL to post poor total returns numbers YTD and over the past year, which include reinvestment of the dividends. Morningstar calculates the YTD and 1 year total returns through 11/21/14 to be -7.61% and -6.96% respectively. The total annualized return over 3 years is +30.18%.
Based solely on tax considerations, it would make more sense to own this security in an IRA. I did not see any tax information at the sponsor's website, but I am assuming that all of the dividends would be taxed at ordinary income rates rather than at the qualified dividend rate. However, I view BDCL to be too risky for a retirement account and consequently bought the shares in a taxable account.
Net Asset Value Destruction by Several BDCs:
Several externally managed BDCs have a history of destroying the net asset value per share number. This is particularly important for a long term investor since the market price tends to hug the NAV per share number within a few percent above or below.
I have noted that less than stellar management performance in connection with AINV, PSEC and TICC. It applies to others as well.
6/30/07: $19.09 NAV Per Share
9/30/14: $ 8.72 NAV Per Share
6/30/06: $15.31 NAV Per Share
9/30/14: $10.47 NAV Per Share
6/30/06: $13.81 NAV Per Share
9/30/14: $ 9.40 NAV Per Share
6/30/06: $15.04 NAV Per Share
9/30/14: $ 9.97 NAV Per Share
3/31/07: $14.78 NAV Per Share
9/30/14: $ 7.67 NAV Per Share
6/30/08: $13.3 NAV Per Share
6/30/08: $ 9.71 NAV Per Share
Incentive Fees, for what? Possibly, the decline in market prices for several BDCs this year is based on a growing recognition that the preceding record is far from admirable and certainly not worth the compensation being paid to the managers of those firms.
Some of the internally managed BDCs have a history of increasing their net asset values:
Disclosure: The author is long BDCL.
Additional disclosure: I am not a financial advisor but simply an individual investor who has been managing my own money since I was a teenager. In this post, I am acting solely as a financial journalist focusing on my own investments. The information contained in this post is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sell of securities. Nothing in this post is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. Each investor needs to assess a potential investment taking into account their personal risk tolerances, goals and situational risks. I can only make that kind of assessment for myself and family members.