Need Yield? Try These 5 Best BDCs for 2021

If you're looking for stable, high-yield income, business development company (BDC) stocks should be on your short list. BDCs are generally some of the highest-yielding equities available, and today is no exception.

BDCs are similar to their cousins, real estate investment trusts (REITs), in that both were creations of Congress to stimulate investment, and both benefit from preferential tax treatment. They pay no income taxes at the corporate level so long as they pay out at least 90% of their net income to their investors as dividends. This is why BDCs, along with REITs, tend to have such high dividend yields. They're legally mandated to pay out nearly every red cent.

BDCs are essentially private equity funds. The only real differences are that private equity funds tend to be opaque, have long lockups and are restricted to high-net-worth and institutional investors, whereas BDCs can be bought and sold like any other stock on the major indices.

Think of business development companies as private equity funds for the common man. BDCs make debt and equity investments primarily in established companies, though most focus on "middle market" companies that are often a little too small for the big boys in private equity. This is as close to "Main Street" as Wall Street gets.

And as with private equity managers, BDC executives are not passive portfolio managers. They will often take an active role in advising their portfolio companies.

While the stock market has been on fire for most of the past several months, many BDC stocks remained far below their pre-COVID prices, which is the sort of thing that will get your attention in an otherwise expensive market.

Read on as we explore some of the best BDCs for those seeking out high yield in 2021.

Data is as of Jan. 10. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price.

1 of 5

Main Street Capital

• Market value: $2.1 billion
• Dividend yield: 7.7%

If BDCs are as close to Main Street as Wall Street gets, it only makes sense to start with Main Street Capital (MAIN, $31.85), one of the few blue chips in this space, and generally considered among the best BDCs on the market.

Main Street provides financing to middle market companies that are a little too large for a bank loan, but not quite large enough to effectively do a stock or bond offering. Its average portfolio investment size is just $13 million.

MAIN, which is among a handful of Wall Street's monthly dividend stocks, has one of the smartest dividend policies you'll ever see. Remember: BDCs are required to pay out virtually all of their earnings as dividends. Yet BDC earnings can be cyclical. So, whenever earnings take even a short-term hit, many BDCs are put in the unfortunate position of having to choose between funding the dividend with debt or cutting it.

Well, Main Street avoids that problem by keeping its regular dividend fairly modest and topping it up with special dividends twice per year. If times get tough, the special dividend gets squeezed.

This conservatism served the company well in 2020. While many companies across the board had to cut their dividends, Main Street was able to keep its regular monthly dividend intact.

At current prices, Main Street yields a very nice 7.7%. And that's without the benefit of any special dividends. MAIN didn't authorize any special distributions in 2020, but you can bet they'll return once the economy normalizes.

2 of 5

Ares Capital

• Market value: $7.2 billion
• Dividend yield: 9.4%

Ares Capital (ARCC, $17.00) is the world's largest BDC by market cap with a value of nearly $7 billion. It also one of the more conservatively allocated: 45% of its portfolio is invested in first-lien loans, with another 28% in second-lien loans. This means Ares is generally first in line to get paid, or awfully close to it. Only 12% is allocated to equity.

Ares is also very well diversified by sector. Healthcare and software make up 19% and 14% of the portfolio, respectively. Commercial and professional services make up 9%. And no other sector accounts for more than 7%. But perhaps most importantly, given the long-term damage to the economy being done by the COVID pandemic, hotels and gaming make up less than 1% of the portfolio, and retail makes up only about 2%.

Raymond James recently offered up a vote of confidence in this BDC, reiterating its Outperform rating and raising its 12-month target price from $16 per share to $17.50. "Core NII (net interest income) / Share estimates are revised upwards as a result of stronger originations in 4Q20 and higher portfolio churn (greater originations and repayments) in 2021," analyst Robert Dodd writes. "NAV / Share estimates are revised upwards as a result of greater prepayment fee expectations."

ARCC didn't lower its regular 40-cent quarterly dividend in 2020, but it did stop paying the additional 2-cent "top-up" dividends it paid across 2019, effectively reducing the income it distributed by less than 5%.

But Ares still yields well more than 9% based on the current payout. That's not bad at all given that ARCC is often considered to be among the best BDCs in the space.

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Apollo Investment

• Market value: $757.0 million
• Dividend yield: 10.6%

Apollo Global Management (APO) is one of the largest and best respected names in private equity with nearly half a trillion dollars in assets under management. Yet most investors will never have the opportunity to invest in an Apollo private equity fund. The minimums are simply too high for the typical investor.

But ordinary investors wanting access to Apollo's management can most certainly buy shares of the Apollo Investment (AINV, $11.70).

AINV primarily makes loans to middle market companies. These lending operations make up about 79% of its portfolio. As of its most recent quarter end, the company had invested a total of $21.5 billion across 541 portfolio companies.

Today, AINV managed a $2.6 billion portfolio spread across 147 companies in 29 industries. If the company has one specific area of risk, it would be its 13% position in aircraft leasing company Merx Aviation. Anything related to air travel has suffered during the pandemic, of course, and Merx is no exception. But as the world starts looking a lot more normal in 2021, these risks should recede.

In the meantime, we can get shares of AINV at prices we might never see again. The company trades for just 0.7 times book value, meaning we're getting a dollar's worth of assets for just 70 cents.

AINV also reduced its dividend in 2020. But it did supplement its regular dividend with special payouts twice last year. The stock currently yields 10.6% based on the regular dividend alone, and 11.4% once the special dividends for the past two quarters are included. Either way, it's a sufficiently high income stream.

4 of 5

Sixth Street Specialty Lending

• Market value: $1.4 billion
• Dividend yield: 7.9%

If you believe that interest rates will be normalizing in the coming years, then Sixth Street Specialty Lending (TSLX, $20.89) is an interesting proposition. Substantially its entire portfolio is invested in floating-rate loans, meaning that the company should be well insulated from rising yields in the coming years.

Like the other BCS in this list, Sixth Street is well diversified. Its largest investor makes up only 3.8% of the portfolio. TSLX also is one of the more technology-focused BDCs on the market. Business services, which tend to be tech-heavy, make up the largest industry composition at 22.9%, and internet services make up another 5.2%. But even among more traditional sectors, like finance and human resources, Sixth Street's portfolio companies tend to have a technology focus.  

Let's talk dividends. TSLX was one of the few companies that actually managed to raise its regular dividend in 2020. And like Main Street, it follows the best practice of topping up its regular quarterly dividends with supplemental and special dividends. Based on the regular dividend, Sixth Street yields 7.9%. The supplemental dividend varies wildly from quarter to quarter, but should be good for another couple percent per year in income.

Keefe, Bruyette and Woods is especially bullish on this stock, recently highlighting it among its best BDCs heading into 201. In fact, it named TSLX and our final pick "best-in-class performers."

"TSLX is the only BDC we cover to have grown their book value thus far through this pandemic," writes KBW's Ryan Lynch, who rates the firm at Outperform (equivalent of Buy). "That is an incredible feat for any BDC to be able to generate net portfolio gains during a recession."

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Hercules Capital

• Market value: $1.7 billion
• Dividend yield: 8.7%

The other BDC receiving high praise from Lynch is Hercules Capital (HTGC, $14.80), which is a more aggressive play.

Most BDCs are essentially private equity funds for regular investors. But Hercules is different. It's more like a venture capital firm.

To those outside the industry, this might sound like a distinction without a difference, but private equity and venture capital are actually very different. Private equity firms deal primarily with established, if somewhat smaller, companies. Venture capital tends to focus on newer firms and startups. This focus on the new and unproven makes venture capital riskier than private equity but with the potential for higher returns.

This brings us back to Hercules, the largest BDC in the world focused primarily on venture lending. The company's primary focuses are in technology, healthcare and renewable energy.

About 36% of the portfolio is invested in drug discovery and development. 31% is invested in software companies, and another 20% is invested in internet services. Sustainable energy makes up a smaller 2.5% of the portfolio, and no other industry makes up more than 2% of the total.

"The venture lending space is a very attractive market, but takes a unique skillset and relationships to be successful," writes KBW's Lynch. "We believe this creates some barriers to entry for potential competitors to HTGC."

Hercules stock has given investors a wild ride over the past year. HGTC topped out at $16.40 pre-pandemic before collapsing to a low of just $5.42 during the pits of the COVID crash. Since then, the stock has clawed its way back to nearly $15 per share.

In late 2018, Hercules started the best practice of keeping its quarterly dividend relatively conservative and topping it up with supplemental dividends. This enabled the company to keep its regular dividend intact even when times got rough in 2020. At current prices, HTGC yields 9% based on its regular payout. The special dividends have been sparse over the past year but should add another couple percent in income as the world starts getting closer to normal.