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Published: August 18, 2010
I've mentioned before that I often go off
the beaten path to find the best income investments in
High-Yield Investing and High-Yield International.
These days you have to -- remember that the common stocks in the
S&P 500 yield only 2% on average.
Luckily, there is an entire world of securities created with
income investors in mind. You just have to know where to look.
Case in point: I've been tracking a rare breed of company --
there are only about three dozen of them on the market. But
these rare securities pay hefty yields, with a few exceeding
12%.
These companies are the 21st century version of
venture capital funds. You've heard of venture capital -- it
generated a lot of press (and billions of dollars) during the
tech bubble. These companies invested in start-ups like
Google (Nasdaq: GOOG) and Amazon (Nasdaq: AMZN),
and made millionaires out of many of their investors.
But the venture capital world has historically been closed to
all but the very wealthy. And it certainly hasn't thrown off
high yields for average investors. That's until this new kind of
income investment came to light. Now investors can invest just
like venture capitalists -- putting money into small companies
off-limits to most -- while being paid double-digit yields. And
they can do it by easily buying and selling shares on the NYSE.
This comes thanks to
business development companies -- or BDCs for short -- which
make loans to small companies, often taking an equity stake as
well. Most importantly, BDCs pass along the income earned from
these investments, allowing them to pay great yields for
aggressive investors -- many currently yield 8-11% and a few are
yielding 12% or more.
Yields are powered by the high-interest loans BDCs offer the
companies they invest in. But yields are also given a boost
because BDCs enjoy a tax-advantaged status. They pay nothing in
income taxes as long as they distribute at least 90% of taxable
income to investors. Dividends are paid at least quarterly and
some even pay monthly.
But business development companies have been around for a while
now, so why am I bringing them up?
To complement their high yields, BDCs look to be in a "sweet
spot."
Right now, conventional lenders have tightened up lending,
leaving many companies with few options to fund growth. BDCs are
one of the few sources of financing available for these
businesses; a captive market is good for business.
But as I said above, these yields are for aggressive investors
as investing in small companies (especially in a soft economy)
can be risky. During the height of the recession, several BDCs
were forced to cut distributions to investors.
To offset their investment risk, BDCs don't invest in just any
company -- the best BDCs use their expertise to be highly
selective. They find undervalued businesses with strong
potential and guide their growth by taking seats on their boards
and providing consulting advice.
These BDCs also manage risk by holding the bulk of their assets
in debt securities. That way, if a company it invests in goes
south, the BDC stands a better chance of being paid for its
investment compared to an equity stake. BDCs further diversify
their risk by owning stakes in many companies at once. The
typical BDC spreads the risk across 50 or more different
companies and 20 different industries.
With their diversified portfolios (and currently low borrowing
rates), I expect select BDCs to continue to be a solid -- albeit
still volatile -- place to earn a strong yield... if the
economy can at least tread water.
-- Carla Pasternak
Editor
High-Yield Investing,
High-Yield International |
