With business development companies, investors are often seduced by high dividend yields, forgetting to focus on some of the key details that separate a "Grade A" BDC from a merely mediocre one. Previously, I've discussed the importance of portfolio valuation, internal vs. external management teams, and a great number of other factors in a far-reaching guide to BDCs. Apollo Investment (Nasdaq: AINV ) , despite being managed by a more expensive external management firm, is in my mind is the best BDC to emerge from a recent spate of offerings including Prospect Energy and Ares Capital.
The company's quarterly earnings report reaffirmed my belief. Despite the loss of key management players Michael Gross (who was a founding member of Apollo Management, as well as the CEO of Apollo Investment) and Arthur Penn (who was the COO) in the last year, the company continues to perform well. Net investment income nearly doubled year over year to $38 million, and NAV has increased a solid 8% over the last three quarters.
This speaks to one advantage of the externally managed firms: They can often pay higher compensation to attract a deeper management bench. The deep bench is needed to run the various parts of Apollo Management, but given that private equity players do not typically stay in one place for long, it also serves as a great way to promote new rainmakers when the old guard moves on.
One of the strengths of Apollo is its strong deal flow for a relatively young BDC. Gross investments totaled $233.9 million in the last quarter, versus just $46 million in new investments for Prospect Energy last quarter. Apollo has a long way to go before it can approach Allied Capital's (NYSE: ALD ) $630 million in gross investments last quarter or American Capital's (NYSE: ACAS ) $1.2 billion in gross investments last quarter, but the point is: Deal flow drives results. Without strong deal flow, there are less lucrative investments -- these firms typically invest in a tiny, tiny percentage of the deals they see, and for investors, that often means more pedestrian returns.
With these private equity firms continuing to serve their lucrative middle-market niche, bulge brackets firms like Citigroup (NYSE: C ) , Merrill Lynch (NYSE: MER ) , and Goldman Sachs (NYSE: GS ) focus their advising on the latest billion-dollar private equity buyout.
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Fool contributor Stephen Ellis does not own shares in any companies mentioned. You can view the stocks he owns and check out his 99th-percentile ranking in Motley Fool CAPS, the Fool's new stock-rating community. The Motley Fool has a disclosure policy.