The Federal Reserve’s 0% rate policy will be cut in stone for the foreseeable future. If you are a large fund manager, that makes borrowing money a gift from heaven. It’s almost free to leverage one’s position at some firms, and even some retail brokerages are offering margin rates as low as 1.3%.
In my 26 years of trading the markets, I’ve never seen an opportunity to lean into such a well-thought-out strategy.
Fund managers are making wide use of leveraged bearish exchange-traded funds (ETFs) to hedge long positions, so as to not have to jump in and out of the market via sell stops. These ETFs allow a fund manager or investor to “box” an account with offsetting assets that move up two or three times whatever underlying index or sector is moving down. A 3X bearish ETF on the S&P 500, for instance, will gain 3% when the S&P loses 1%. This makes for effective portfolio management during rough-and-tumble times, like the present.
I firmly believe that, in the current investing landscape, pension managers of all stripes — who have to pay out millions of monthly checks to pensioners — are buying high-yield assets and boxing those accounts with leveraged bearish ETFs.
They are willing to forego capital gains for the time being, but are also receiving strong stock dividends and bond interest to make good on pension obligations without cutting into principle. It’s either that or settling for 3% in very short duration paper that doesn’t get the job done.
One vehicle sits right in one of the sweet spots here: commercial lending to small-to-medium-sized businesses, for which banks have failed to “man up.”
While the mega-banks re-inflate their balance sheets with all the blessings from the Treasury Department and Federal Reserve, they’ve left a huge vacuum of qualified companies starving for credit lines to expand business and hire new employees.
Enter business-development companies (BDCs), specialty lending enterprises filling the very void the banks are too scared to address. They are taking on calculated risk and getting paid like a champ to do so.
The average loan they process carries with it an annual interest rate of between 13% and 15%. At the same time, they get an equity interest in the private companies they lend to.
I recommend two of these publicly traded entities, Fifth Street Finance Corp. (NYSE: FSC) and Triangle Capital Corp. (NYSE: TCAP), which have dividend yields of 11.1% and 9.6% respectively.
With a strong breeze to the back of the BDC sector, I thought it very timely that UBS came to market with our newest trade, 2x Leveraged Long Exchange Trade (NYSE: BDCL). An exchange-traded note, it’s tied to the Wells Fargo Business Development Company Index, and is comprised of 26 of the top BDCs traded.
Because of the 2x leverage, shares of BDCL pay an estimated forward dividend yield of 14.57% at a price of $25 per share. Now this is what I can get excited about!
It’s a sector with improving fundamentals, has a security structured like a REIT, is mandated to pay out at least 90% of cash flow in the form of quarterly dividends, has yields averaging 7.5%, and the ability to leverage that 7.5% at almost no cost to the issuer.
That’s how retail investors can make use of leverage in this market without buying on margin. It’s a beautiful thing.
