BDC Market Update
This year has been difficult for BDCs due to being removed from the S&P and Russell indices, continued interest rate fears, general declines in small caps, selling institutional shareholders over the last two quarters and December tax-loss sellers. I believe that some investors have been selling baskets of investments, including higher quality BDCs, which has created an opportunity for investors. At some point, BDCs will rebound and I will have a series of articles coming out that discusses many of the positive signs that we are seeing including lower borrowing costs, stabilizing or even increasing portfolio yields and less competition from banks as they continue to exit level 3 assets.
Over the next two to three weeks, BDCs will either continue to fall, have a ‘dead cat bounce’ or potentially have a sustained rally into 2015. Investors should be ready for all three of these scenarios and to buy preferred BDCs over the coming weeks. As shown in the previous chart, I believe investors are currently reacting out of fear (in both the general and BDC markets). The following chart shows the VIX hitting a high in mid-October at the same time BDCs hit a low for the year and there are signs that the VIX is headed to these levels yet again. Volatility – or “market whiplash” – is clearly back in the market.
The CNN Money Fear & Greed Index:
Investors are driven by two emotions: fear and greed. Too much fear can sink stocks well below where they should be. When investors get greedy, they can bid up stock prices way too far.
“We look at 7 indicators: For each indicator, we look at how far they've veered from their average relative to how far they normally veer. We look at each on a scale from 0 - 100. The higher the reading, the greedier investors are being, and 50 is neutral.”
Source: CNN Money
What should investors do over the next few weeks?
Investors should be ready to buy BDCs that fit their investment profile. Recently I have noticed that pricing multiples have changed to reflect investors’ perceptions of dividend coverage and risk or capital preservation. BDCs that continue to trade at lower NAV per share multiples will be capital constrained and could risk losing various credit ratings that could contribute to a higher cost of capital.
There will likely be continued basket and tax-loss selling but at some point I believe BDCs will rebound sharply as they did after the October 15th lows. Also I believe investors will continue to pay higher multiples for higher quality BDCs giving them a clear advantage going into 2015.
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