Getting Booted From Two Major Indices Opened the Perfect Buying Opportunity For These 3 Big Dividend Stocks

Kicking BDCs out of the index may help falling middle-market yields.

Apr 22, 2014 at 11:12AM

When S&P and Russell announced they would remove business development companies (BDCs) from their indices, they may have given the industry a big gift.

Following the announcements, BDCs sold off. Prospect Capital (NASDAQ:PSEC) and Apollo Investment Corporation (NASDAQ:AINV) were some of the hardest hit, as they are included in more indices than the average BDC. But they certainly weren't the only companies affected. The BDC Income ETF (NYSEMKT:BIZD) has traded lower by roughly 5% since the announcement, suggesting losses have been widespread.

BIZD Chart

Why it may prove beneficial
BDCs are nothing more than shells that move money from Wall Street to Main Street. Unlike banks, BDCs don't take in deposits. They don't provide a service to receive low-cost funds. Rather, they rely on "wholesale" funding, usually in the form of debt financing and equity issuance.

In effect, a BDC's main service is borrowing money from one group (Wall Street) and investing it in another group (small businesses).

Naturally, share prices are very important to BDCs. When share prices are high, BDCs can raise new funds to invest. And when BDCs can raise new funds, more money flows into the middle market.

Competition goes both ways
The middle market is considered illiquid and less competitive than the public market. Financiers still have to source their own deals; there's no convenient or massively liquid market to buy and sell investments in tiny businesses.

But fund flows still have an impact on BDCs. When money chases yields, yields go down. Finance is, after all, a very competitive business.

In the past year, so-called "hot money" has driven down yields. Apollo Investment Corp's average yield on its portfolio fell .5 percentage points, from 11.9% to 11.4%, in the last four quarters. Likewise, Prospect Capital's average yield fell a full percentage point in just three quarters, from 13.9% to 12.9%, during March 2013 to December 2013.

Middle Market Yields

Some have seen bigger yield compression, particularly those that have shifted to lower-risk first- and second-lien debt. Smaller THL Credit (NASDAQ:TCRD) experienced 2 full percentage points of yield compression --13.7% to 11.7% -- in the last year.

Why a drop might help
This quarter, we've seen very little big fundraising activity. Prospect Capital filed for a relatively small offering to sell 20 million shares this quarter, roughly equal to 4% of its balance sheet. Apollo Investment Corp. offered shares to the public at the same time as the index announcements, but it was only for 13.8 million shares, or about 6% of the outstanding share count.

THL Credit likely won't be raising any new cash at all.

On one end, falling share prices are obviously concerning to investors -- no one wants to see their share prices go down. But the truth is, lower prices may help relieve some of the competitive pressures in the middle market that are driving up middle-market valuations. With the indices selling, BDCs don't want to add to it by issuing new shares of stock.

And that could be very good for the middle market. Less money flying around means less pricing competition for deals. It wouldn't be unreasonable to expect that first quarter earnings calls report that middle market yields were higher in the first quarter of 2014 than the fourth quarter of 2013.

That bodes well for the BDCs, even if you have to tolerate lower share prices in the interim.

Are these tax-efficient yields better than BDCs?
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers