3 BDCs to Buy for Double-Digit Yields

If you're on the hunt for high yields, don't overlook BDCs

When it comes to high-yielding investment vehicles, real estate investment trusts (REITs) and master limited partnerships (MLPs) are the most well-known. Almost every portfolio has exposure to them these days.

best dividend stocks bank stocksThe vast majority of 401(K)-styled retirement plans offer some sort of REIT option these days. But there is another pass-through entity that investors looking for high-income should familiarize themselves with.

We’re talking about business development companies (BDCs).

Investors can think of BDCs as publicly traded private equity or venture capital firms. Many midsized firms are too small to launch a full corporate bond issue and are too large to go their local bank branch and request a loan.

Finding sources of capital can actually be quite difficult. BDCs will step in a loan those firms the needed money — often at very advantageous rates and with an equity kicker.

The bonus for investors is that BDCs are required to pay out at least 90% of their income back to shareholders as dividends. That requirement results in some large dividend yields for the stocks — usually in the 9% to 15% range.

With more than 50 BDCs now trading on the exchanges, investors have plenty of choice to get their high-yield BDC fix. Here are three quality BDCs to buy with double-digit dividend yields.

BDCs to Buy for Double-Digit Yields: Hercules Technology Growth Capital (HTGC)

Yield: 10.9%

dwayne-johnson-hercules
Source: Twitter

Ever hear of Facebook (FB)? Real estate analytics website Trulia? What about Aegerion Pharmaceuticals (AEGR)? Well, BDC Hercules Technology Growth Capital (HTGC) invested in them all before they were well-known technology companies.

In fact, HTGC has directly invested in 320 different technology, life sciences and alternative/renewable energy companies over its history. And it has been pretty successful at spotting the next big thing. The vast majority of its portfolio has experienced exit events like buyouts or IPOs. In fact, Hercules saw three of its investments go public this year alone.

That success stems from the fact that Hercules lets other private equity and venture capital firms do most of the heavy lifting first. HTGC swoops in and provides a full range of “venture debt” financing options for the backed firms. At the same time, it’ll take an equity stake as part of the financing package. That strategy provides current income from the debt issued as well as capital appreciation potential from various exit events.

All of this creates steady and growing cash flows, which trickle back to investors. Since its IPO back in the 2005, the BDC has paid out a total of $10.61 in dividends per share. Not bad for a stock that went public at $13. Today, investors can snag HTGC with a 10.9% dividend yield.

BDCs to Buy for Double-Digit Yields: Ares Capital Corporation (ARCC)

ares-capital-arcc-185Yield: 9.6% (plus special dividends)

When it comes to BDCs, Ares Capital Corporation (ARCC) is one of the elder statesmen. Started by private equity group Ares (ARES), the BDC has one of the largest lending portfolios around.

ARCC currently has senior secured loans, mezzanine debt and equity investments in nearly 201 different firms worth about $8.5 billion. That portfolio is diversified across a variety of sectors, with healthcare, consumer products and power generation making up the bulk.

The strength of that portfolio comes from its relationship with Ares, as ARCC’s parent will often kick business from its own investments down ARCC’s way. That portfolio has also been benefiting from its working relationship/joint venture with GE Capital. However, with GE (GE) now planning on selling its financing arm, ARCC shares have been in flux.

But investors shouldn’t worry too much. ARCC has already moved in and found other partners to fill the void. Meanwhile, shares of the BDC have traded down about 7% since GE announced its plans.

Now is a great time to strike. ARCC is trading slightly below book value and sports a juicy 9.6% dividend yield. That yield jumps into double-digit territory, if you include the additional and special dividends the BDC has paid every year since 2012.

BDCs to Buy for Double-Digit Yields: Pennant Park Investment Corporation (PNNT)

pennant-park-pnnt-stock-185Yield: 13.3%

For investors looking for a bit more yield and a potential turnaround play in the BDCs sector, then Pennant Park Investment Corporation (PNNT) is a top pick. Since going public just before the recession, PNNT has been quite successful at growing its lending portfolio. Today, PNNT provides senior and mezzanine debt to 67 firms for a total of $1.3 billion dollars.

The only problem is what kind of firms PNNT has been lending to.

Pennant Park has been stepped up its lending activity to the energy sector over the last few years as fracking as grown. Unfortunately, as oil & gas prices have dropped, profits and cash flows at smaller E&P firms have also plunged. That makes it harder to pay back loans. Needless to say, PNNT has plunged on these fears — part of the reason for its high dividend.

The saving grace is that PNNT’s debt in these areas are extremely high on the capital ladder. That means in the event of bankruptcy, PNNT often gets first crack at assets. Secondly, the slowdown in drilling seems to be finally working its way throughout the system and energy prices are on the rise.

As such, PNNT’s dividend yield is still pretty safe.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

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