Consider Investing in BDCs for Current Income

 | May 12, 2018 | 12:00 PM EDT
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We, apparently, have been cursed to live in interesting times.

As the Fed raises short-term rates, things are getting better for investors seeking current income, says Scott Stone, the chief Investment Officer at Pentegra Services. "However, the markets today price risk as though there isn't any to speak of," he says.

For those who need income and can handle the risks, Stone suggests looking at high-quality business development companies (BDCs) where yields of 6% or more are common, with underlying loans or asset-backed deals that have security in collateral and liens.

How might one go about finding and buying high-quality BDCs?

For starters, follow the writings of Jonathan Bock, director and senior equity analyst at Wells Fargo Securities. Bock specializes in BDCs, has actively followed the BDC space since 2006, and is the chief author of BDC Scorecard, a quarterly research publication.

From Investopedia: A business development company (BDC) is an organization that invests in and helps small- and medium-size companies grow in the initial stages of their development. Many BDCs are set up similarly to closed-end investment funds and are typically public companies whose shares are traded on major stock exchanges, such as the American Stock Exchange (AMEX), Nasdaq and others.

Others also say now is tough market for retirees looking for current income. "Corporate bond yields are nearly at inflation rates, and I believe corporate defaults are going to increase over the next year, pushing total return below CPI," says Steven McClurg, the chief investment officer at ARCA.

McClurg also believes the yield curve will continue to flatten as the short end rises, making it difficult to safely invest against duration risk.

"We are due for another recession, which I believe will be induced by corporate defaults sometime next year," he says. "And if you look at equity markets, they typically drop 40% when defaults are double digits, so there is a danger in dividend-paying stocks."

The only safe place, says McClurg, might be government-backed mortgage-backed securities, or even real estate, at the moment. "REITs have been hit hard, but I don't think they are entirely out of the woods," he says. "Retail REITs could suffer more in a recession, so I believe they should be chosen wisely."

What REITs might investors consider? "I like data center REITs given the increased investment in [artificial intelligence] and cloud," says McClurg.

Data center REITs include Equinix (EQIX) , CyrusOne (CONE) , Digital Realty Trust (DLR) , CoreSite Realty (COR) , and QTS Realty Trust (QTS) .

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