An Idea to Fight Inflation That Actually Works

Business Development Corporations (BDCs), Inflation, Investing Strategies

In late 2021, when it became apparent that inflation would stay persistent and increasing, I started to get a lot of questions about where to invest.

When inflation rears its ugly head, there is no magic list of investments that help you beat inflation all of the time. While it would be good if there were such a list, I advised looking for companies and stocks that would see profits grow with higher interest rates.

One particular idea I shared has proven to work out very well…

For many months, as inflation took off, the Federal Reserve continued to call the inflation “transitory” and kept interest rates low. While the Consumer Price Index was pushing 8% as early as February, the Fed did not get serious about raising interest rates until April, and the fed funds rate didn’t go above 1.0% until June.

As a result, for those companies that benefit from higher rates, the increases in interest rates have lagged inflation by many months. Only now, as third-quarter earnings come out, do we see the effects of higher rates. In the meantime, the stock market has double dipped into bear market territory, putting us at a point at which these companies are ratcheting up profits and dividends while, at the same time, share prices are low.

Business development companies (BDCs) provide financing solutions for small-to-medium-sized corporations. BDCs operate under special laws that require them to pay out 90% of net investment income as dividends. As a result, BDC shares sport very attractive yields.

Almost all BDCs make variable-rate loans to their client companies. The BDC rules also require a BDC to maintain a low debt-to-equity capital structure. The structure allows a BDC to generate growing net interest income as interest rates increase.

The effects of higher rates kicked in during the 2022 third quarter. BDC dividend increases have been hitting my inbox almost daily. It’s gotten a level at which, if you own shares of a BDC that hasn’t increased its dividend, I would look at selling and investing in one that is now growing its payout.

Here are the four largest BDCs by market cap, with their most recent dividend changes:

On October 25, Ares Capital Corp. (ARCC) announced a $0.48 per share dividend to be paid on December 29. The new dividend was 12.3% more than the previous dividend. Ares has increased its dividend twice this year and paid several small supplemental dividends; it yields 9.7%.

FS KKR Capital Corp (FSK) pays a variable dividend. The company paid $0.68 per share in July and $0.67 in October; and on November 7, it declared a $0.68 dividend to be paid on January 3. The shares yield 12.7%.

Before its last dividend announcement on November 2, Owl Rock Capital Corp. (ORCC) had paid a level dividend since its July 2019 IPO. On November 2, ORCC increased its dividend by 6.5%. Company management also announced supplemental quarterly dividends would be paid as profits allow. Owl Rock Capital yields 10.2%.

On September 7, Blackstone Secured Lending (BXSL) increased its dividend by 13.2%. The company has also paid hefty supplemental dividends. This BDC is just a year old, so investors should review quarterly earnings to look for a trend of future dividends. Blackstone Secured Lending yields 10.2%.

You can see how the BDC sector is on a path of growing dividends combined with excellent yields. Dozens of companies use the BDC business structure, and with the Fed continuing to raise rates, 2023 will be a great year for BDC dividends.