Ares Capital: High Yield and Floating Rates

03/22/2018 5:00 am EST

Focus: FINANCIALS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

High yield has fallen from favor. Because many high-yield stocks are low-growth companies with high payout ratios, high-yield stocks are viewed as bond-like investments, explains Ian Wyatt, income expert and editor of High Yield Wealth.

The concern is that bonds and bond-like investments are vulnerable to rising interest rates. One of our high-yield recommendations is bond-like. Unlike most bond-like investments, though, we expected it to benefit from rising interest rates. 

Ares Capital Corp. (ARCC) is a business development company (BDC). It invests in the debt and equity of privately owned companies. The company offers a 9.6% dividend yield.

The BDC strategy is to borrow at a lower rate and either lend or own securities that generate a return in excess of borrowing costs. The structure of the loans made, and loans incurred will influence the spread between borrowing costs and investment return. 

Ares Capital invests primarily in noncyclical businesses with attractive growth prospects and high free cash flow. About 21% of the portfolio is health care, 19% is business services, and 7% is consumer products. Its investment portfolio is valued at $11.8 billion and is composed of the securities of 314 different companies.

Ares Capital management has anticipated the future and it has structured its debt capital and loan portfolio accordingly. 

Its debt capital is 82% fixed rate and 18% floating rate. The loan portfolio is 91% floating rate. If interest rates rise, Ares Capital’s borrowing costs should remain stable. On the other side, interest earned from its loan portfolio should rise as loans are reset at a higher rate. 

The stock is one of our longest-tenured recommendations. It has been a High Yield Wealth recommendation since February 2011. Ares Capital is also one of our highest-yield recommendations. The high yield has been proven secure.

Ares Capital has never lowered its quarterly dividend its tenure. It has occasionally supplemented its quarterly dividend with an additional payment. Should Ares Capital generate more net investment income on rising interest rates, more cash should be passed along to investors as dividends. 

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