Persistent inflation and rising interest rates have been at the forefront of investors' minds for most of this year.
On Sept. 21, the Federal Reserve raised interest rates by 75 basis points (0.75%) once again, continuing its fight against inflation. These rapidly rising interest rates have shaken the market, with the S&P 500 down more than 24% since the start of the year.
At times like this, conservative investors are searching for security and protection from inflation. The Blackstone Secured Lending Fund (BXSL -0.09%) is one dividend stock that could guard you from inflation and the effects of rising interest rates. The company has a high dividend yield and benefits from higher rates. Here's how.
Blackstone Secured Lending Fund looks to fill a hole created by banks
Blackstone Secured Lending Fund invests in private company debt to generate income for investors. The company operates as a business development corporation (BDC). BDCs fund companies through loans and equity investments, following similar tax rules that are similar to those for real estate investment trusts (REITs). One of those rules requires BDCs to pay out 90% of their taxable income in dividends, making them attractive high-yield stocks for income investors.
The Blackstone Secured Lending Fund sees an opportunity to serve private companies' growing demand for credit and leverages Blackstone's platform to identify attractive investment opportunities in private companies.
Regulation hit banks hard following the Great Recession from 2007 to 2009, and they stopped making as many loans to companies as a result. According to S&P Capital IQ LCD, U.S. banks' share of senior secured loans went from 33% in 1995 to just 8% in 2022. The number of banks has consolidated, too, causing a supply shortage of lending to private companies.
Here's what the business does
Under normal market conditions, the fund aims to invest 80% of its total assets in secured debt investments. The fund invests in 163 portfolio companies which have an average yield of 7.8%. The fund primarily invests in first-lien secured loans, which make up nearly 98% of its total portfolio.
Debt investments have liens or a claim on collateral a company pledges to secure financing. These liens determine who gets paid first if a company can't repay its loan. First-lien secured loans have the first claim on collateral, so if a company goes under, these debt holders get paid off before anyone else. This can make the investments safer than second-lien loans or equity investments, which get lower priority in the event a company is liquidated.
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Why Blackstone Secured Lending Fund could be a good inflation hedge
The fund's potential to hedge against inflation and rising interest rates makes it attractive. Over the past year, inflation has remained stubbornly high due to enormous fiscal stimulus amid the pandemic, supply chain issues, and rising costs of housing and food.
To fight inflation, the Federal Reserve is raising interest rates at a pace we haven't seen in decades. Since March, the federal funds rate, or the rate banks can lend money to each other overnight, has gone from 0.25% to 3.25%.
Rising interest rates increase the yield of Blackstone Secured Lending Fund's debt investments, which are nearly 100% floating rate instruments. These higher rates can lead to higher interest costs that benefit the fund and its investors. Through the first half of this year, the fund's net investment income (NII) increased 41% from last year to $208 million.
In its regulatory filing from June 30, the fund noted that a 100-basis-point increase would cause NII to go up by $73 million, while a 200-basis-point increase would cause it to go up by $147 million. Since that date, the Federal Reserve has raised the federal funds rate by 150 basis points.
The risks of investing in the BDC
While rising interest rates increase the fund's investment income, rates that increase too quickly could pressure those companies' ability to repay their debts. Furthermore, the value of the fund's debt investments could fall due to higher interest rates.
One way the fund hedges this risk is by investing in those first-lien loans, giving it a priority in the event of bankruptcy. It also spreads the risk among companies and industries, so it isn't too concentrated. Its largest industries are software and healthcare providers and services, making up 14% of its portfolio. The fund has $890 million in liquidity and undrawn debt, and 55% of this debt is fixed with an average rate of 2.97%.
Investor takeaway
The risk of investing in the fund is that companies begin to default in waves, resulting in liquidations instead of a steady flow of income. The fund could also get squeezed if interest rates return to the lower levels we grew accustomed to over the past decade.
Brad Marshall, chief executive officer of the Blackstone Secured Lending Fund, is optimistic, saying that "despite potential headwinds in the economy, we think the outlook for shareholders is bright, given a portfolio that is well positioned for this environment and significant earnings growth potential from higher rates."
With a dividend yield of 10.4%, the company looks like a solid dividend stock that could provide investors with a good hedge if inflation remains stubbornly high.
