BDC COMMON STOCKS

Week 22

Unstoppable?

There does not seem to be any obvious catalyst that might end the BDC sector’s rally that began way-back in September 2022.

As the chart of BDCZ – the exchange traded note which owns most BDC stocks and serves as a sector guide – shows, there have been many challenges along the way.

Nonetheless, BDCZ has inexorably moved upward, going from a closing price of $15.52 to $19.92 – a 28% price increase.

We get the impression that BDC prices are increasingly detached from what happens in the broader market.

This week was a case in point.

The S&P 500 and Nasdaq were down (0.51%) and (1.1%), respectively. The Dow slipped (0.98%).

Don’t feel too badly for the major indices:

“It was a winning May, with each of the major benchmarks registering a sixth positive month in seven. The Dow added 2.3% this month, while the S&P 500 rose 4.8%. The Nasdaq gained 6.88%, notching its best month going back to November”.

Unaffected

We might have expected BDC prices to come off slightly after Friday’s unexpectedly on point core PCE result for April.

Tamer inflation raises the possibility of the Fed cutting rates earlier rather than later which will translate into lower BDC earnings – possibly as soon as the IVQ 2024. That phenomenon MIGHT bring down BDC prices.

Instead, BDCZ moved up 0.9% on Friday as did 90% of BDC stocks.

(Final days of the month can be funny that way).

From The Mountaintop

This week also saw Jamie Dimon – our modern-day Cassandra – adding to the long list of individuals and institutions warning about the future of private credit.

In remarkably strong language equally remarkably absent of specifics, Dimon warned of “hell to pay” if private credit markets “wobble”.

He suggested the trouble would come from “bad actors” and casted aspersions at the ratings groups:

One Of Many

Previously we’ve had dark predictions of doom in November 2023 from UBS Chairman Colm Kelleher who said there was “clearly an asset bubble going on in private credit… what it need is just one thing to trigger a fiduciary crisis.” 

The IMF added its voice to the chorus In April , and suggested – not unexpectedly – more regulation.

A “global strategist” at Jefferies – Christopher Wood – bemoans how institutions are investing ever greater amounts in private credit – and private equity – as opposed to “actively managed equity and fixed income bond products, which offer much greater liquidity”.

He strongly believes that it is “only a matter of time before this approach to investing will be questioned, if not discredited altogether. For it depends on an illusion of liquidity which does not really exist.”

We’ll be addressing these warnings in a stand-alone article shortly.

For the moment, though, investors in private credit seem blissfully unfazed. A near-two year rally will do that.

This Week

Getting back to the micro picture.

The S&P BDC “total return” increased 1.3%, outstripping BDCZ.

32 individual BDC stocks were up in price or flat and 10 in the red.

Only 1 BDC moved more than 3% in either direction.

Stock Of The Week

That was Bain Capital Specialty Finance (BCSF), up 3,.1%.

Coincidentally or otherwise, BCSF’s recent financial performance was covered favorably in the BDC Reporter this week and was listed as a BUY in BDC Best Ideas.

Flying High

Once again, 20 BDCs out of 42 are trading at or above their net book value per share, just off the 2024 record of 21.

Furthermore, 6 BDCs – at least – reached new 52-week price highs this week.

This sort of multiple record breaking has been going on for months now but has noticeably picked up in the last 6 weeks, averaging 8.7 such increases a week.

Year-To Date

Given we are 5 months into the year, let’s see where the BDC sector stands in YTD 2024.

Our trusted price guide BDCZ is up 5.01%. By contrast, the S&P 500 index is up 10.6%.

However, that’s not the end of the story. BDCs pay out a LOT of distributions and those are racking up with over 40% of the year gone.

The S&P BDC “total return” – frankly our favorite metric for buy-and-hold investors – is up 11.2%, just marginally behind the 11.3% total return of the S&P 500.

Averages, though, can hide the huge individual variances in price performance that can occur – even in just 5 months.

Digging Deeper

YTD, 27 BDCs are up in price, 17 are down and Palmer Square (PSBD) does not count because it joined the public BDC party during the year.

The most successful BDC in price terms is up 20% (CGBD) and the least successful is off (17%). That’s OFS.

The median price gain seems to be 4% and total returns – which we don’t have external data for – is likely to be in the 9%-10% range.

Choose Carefully

Here’s where we get back on our soap box to remind our readers about the importance of individual BDC stock selection – identifying the right stocks and – just as importantly – avoiding the BDC “downers”.

If at the beginning of 2024 you’d chosen to go with CGBD, HTGC and BBDC you’d be up 18% on price alone. However, if you’d bought OFS, TPVG and HRZN, you’d be sporting a (14%) loss. Even with distributions taken into account, you’d still be deeply in the red.

Half A Decade

Even over the long term – say 5 years – this dispersion of return performance occurs. According to Seeking Alpha basis, the highest and lowest returns in price terms since May 2019 are 65% up and (80%) down respectively. On a total return basis, the top performer is up 175% and the worst (59%).

That 175% top returner – which happens to be HTGC, if you’re wondering – vastly outperformed the S&P BDC Index on a total return basis, which was 62%.

(Seeking Alpha and S&P probably use different calculations to reach their numbers so this is more of a rough comparison).

Compelled

We realized twenty years ago how important BDC stock selection can be and was one of the key reasons we threw ourselves into the sort of analysis you’ll find in the BDC Reporter.

Over the years, many BDC “bad actors” – to borrow Mr Dimon’s term – have fallen by the wayside and the general quality of BDC financial performance has improved.

Nonetheless, as our recent rating of every BDC’s IQ 2024 financial performance illustrates, there are still wide variations between the 42 players we track.

Current Players

Not that anyone has asked us but looking down our list of BDCs, there are 9 or 10 that we have serious doubts about and which may not be around 5 years from now in their current form.

Even amongst the plurality of “better” BDCs, we foresee that the performance distance between the very best and the also-rans will grow ever wider, especially if the doomsayers are right about trouble ahead for private credit.

If We Were Betting

If this was a horse race and we were using increase in NAV Per Share over the past 5 years as the criteria for selection, the favorites would be GLAD, MAIN, FDUS, SAR and ARCC.

If the criteria was best total return over the last 5 years, the favorites would be HTGC, CGBD, CSWC, FDUS and GAIN.

We’re guessing, though, that when we get to 2028 there will be many surprises about who generated the best performance and the best returns.