Produced in association with Treading Softly.
Breaking away from novelty can be difficult. You get excited when you pass a gas station that charges $3 for gas. That’s well below the $4 or higher we’ve seen lately!
What we forget is that just a year ago, $3 was considered excessive by many and caused considerable concern.
So what happened? Time has passed and prices have gone up, now $3 doesn’t seem so bad compared to $4 or even $6 in some places.
Move to market looks great so far!
However, if we zoom out a bit, we can see that this excitement is misplaced, as the market has a long way to go before a full recovery:
If we look at January 1, 2022, we can see that while recent gains are potentially impressive, the reality is that we are a long way from how 2022 started.
So I’m still bottom-fishing for great income investments that haven’t recovered from their previous lows. They still offer excellent returns. They still have room to give me huge capital gains.
When the market falls 30%, it takes a 60% gain from the bottom to recover. Don’t let the last memory paint reality in a new color.
Let’s look at two fully non-recourse income funds that deserve a home in your portfolio.
Option #1: WE – Income 10.2%
The macro environment is ideal for the BDC (Business Development Company) business model.
Most BDCs provide high-level secured loans with floating interest rates. These are usually term loans or revolving lines of credit. Most of these loans pay floating interest rates. At the same time, BDCs tend to use fixed-rate debt for leverage, creating a scenario where BDCs borrow fixed-rate debt and issue floating-rate debt. Fantastic dynamics when interest rates rise.
BDCs serve the “middle market,” which are businesses that are not publicly traded and can range in size from $5 million to several hundred million with annual EBITDA. Why don’t these businesses take loans from the bank? The answer is that they used to be. In the early 90s, more than 70% of middle market loans were held by banks, which declined sharply during the Dot-com bust and again under banking regulations inspired by the Great Financial Crisis. Source.
Enterprises did not stop borrowing. They just borrowed from somewhere else. In the early 2000s, publicly traded BDCs began to fill the void.
This change is beneficial for everyone involved.
Banks have to worry about liquidity, and these middle-market loans generally don’t trade on the open market, so they’re illiquid. Banks are not very interested in hiring manpower to manage these loans.
Borrowers are not looking for one-size-fits-all loans, they are small and medium-sized businesses and can often benefit from a lender working with them rather than offering a loan.
BDCs don’t just issue the loan and send the bill for the loan payments, they often receive a share from the borrower in addition to the loan. This allows for a lower interest rate for the borrower while providing a higher overall return potential for the BDC. It also means that the BDC has an invested interest in the success of the parent company. It’s no coincidence that BDCs typically have close ties to private equity. It often combines with private equity to provide debt and equity investments. The borrower benefits from cash, but more importantly, gets an active investor interested in providing expertise to ensure the company’s success. Providing a mix of equity and debt investments allows the borrower to balance their capital structure in a way that optimizes their success.
With low defaults and rising interest rates, we’ve seen BDCs thrive. When you expect macro headwinds to benefit all companies in a sector, an ETF can be a great way to get quick exposure. VanEck Vectors BDC Income ETF (BIZD) is a diversified exposure option instead of doubling down on the sector or investing in individual options.
But what about downside risk? Given that BDCs lend to private companies, some fear how a recession could affect the sector. However, during the Great Financial Crisis, BDCs fared remarkably well relative to banks and the S&P 500 Index (SP500).
Here’s a look at 9 BDCs available in January 2008 against SPY and KBE (bank ETF): (ARCC), (BKCC), (GAIN), (GLAD), (HTGC), (MAIN), (PNNT ). ), (PSEC) and (SAR). Source.
Although they fell with the rest of the market, they recovered more quickly.
BDCs are increasing their dividends and experiencing extremely strong fundamentals. BIZD is a great way to increase your exposure to them.
Option #2: BCX – Income 6%
BlackRock Resources & Commodities Strategy Trust (BCX) is a closed-end fund, or CEF, that invests in commodities. Its holdings are divided into three main commodity-sensitive sectors: mining, energy and agriculture. Source.
BCX invests in the biggest names in these sectors. 94% of its shares have a market capitalization of more than $10 billion. Over the past year, we’ve seen the BCX rally in early 2022 as investors became curious and surprised by high inflation. Then in June, the story collapsed as the hawkish Fed took a stand to stop inflation at all costs.
Since then, the price of BCX has not fully recovered. But BCX’s NAV (net asset value) recovered.
This disconnect is likely due to the fact that many investors feel that inflation is slowing. Inflation is slowing; so they don’t want to own inflationary gainers like commodity companies.
But when you look at the company level, these companies are doing very well. They report high earnings and bright prospects. So investors will buy individual companies because they look at earnings and see strong fundamentals. However, they will not buy the sector through the CEF due to the perception that slowing inflation is bad for commodities.
There is clearly a connection. We believe the disconnect is related to how people think about “inflation.” Inflation is not a measure of prices. Inflation is a measure of the rate of change in prices. For commodity companies, this distinction is very important. When we say “inflation is slowing,” we don’t mean that prices are falling. We say that the pace of inflation is slower, but prices are still high. Consider crude oil:
Prices have fallen from their peak last summer. However, compared to where oil has been priced in recent years, it is still about 40% higher than it was before COVID. So even if crude becomes deflationary in annual inflation measures, commodity companies are still priced 40% higher than they were in the pre-Covid years.
Commodity companies may enjoy the occasional windfall in price increases, but the real money comes from keeping prices higher. It is more beneficial for big oil prices to remain around $80 for years than a one-time rise to $110.
This is repeated throughout the commodity sector. Corn, soybeans, iron ore, copper, coal—you name it. Prices are lower than last year (deflationary), but held at much higher prices than in 2019. So you can read about how inflation is slowing, but then go to the grocery store and get sticker shock.
Yes, inflation is slowing.
Yes, prices are still higher than they were a decade ago.
Both are true at the same time. The market has sold off commodity CEFs like BCX as it causes commodity prices to fall due to slowing inflation. However, in the big picture, commodity prices are still high, which benefits the companies that produce them.
With BIZD and BCX, we can get a high level of income today, while their market prices have returned to pre-2022 levels. BIZD will enjoy a higher interest rate environment, which provides a huge increase in income for BDCs in general, and as more money flows into BIZD, more money will flow to you. BCX’s NAV recovered but the market price did not. This dislocation between NAV and market price may allow us to purchase holdings at a discount compared to purchasing the same basket of holdings in the open market.
My retirement is focused on strong income potential from my portfolio, and yours can be too. In most cases, financial strain, stress and disaster can be the main reasons for a retiree to return to work. I like to get my financial house in order so I can enjoy vacations, sunsets in my backyard, or visiting loved ones without pinching every penny or stressing about spending.
My dividends pay for my retirement and they can pay for yours too. Low cost fishing can help you get great investments at incredible prices.
I’ll see you at the lake!