Ares Capital: Where It’s Investing for Future Growth
Second lien investing
Over the past few quarters, Ares Capital (ARCC) has consistently increased its exposure in second lien senior secured debt. Second lien formed 26% of its total portfolio in 1Q15—compared to 15% in 1Q14. In contrast, the exposure in first lien reduced from 45% to 34% in the same period. For second lien debt offerings, the company targets a minimum of 400 bps (basis points) of higher yield than it generates on first lien senior loans.
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The change in the strategy will help the company to boast its average yield on its overall portfolio. The overall risk profile has deteriorated marginally, but remains strong. The weighted average debt-to-EBITD (earnings before interest, tax, and depreciation) of 5x and interest coverage of 3x for its portfolio companies is considered to be a better profile in the low interest rate scenario.
Senior secured loan program
The exit of GE Capital from the SSLP (senior secured loan program) will bring challenges as well as opportunities for Ares Capital. The major challenge for the company will be to find new partners with similar or better capital resources and an understanding of the business. However, the company benefits from a funded portfolio where other players in the market will have to initiate operations from scratch. There’s a certain void with the exit of GE Capital. To a large extent, it can benefit Ares Capital if the company is successful in tapping new partners with sizable resources.
Ares Capital has generated returns of 11.32% on its book equity. This is higher than the peer average of 10.7%. Here’s how a few of the firm’s peers in investment management fared in terms of return on equity:
- Prospect Capital (PSEC) – 8.9%
- BlackRock Capital Investment (BKCC) – 18.4%
- Apollo Investment (AINV) – 8%
Together, these companies form 4.76% of the PowerShares Global Listed Private Equity Portfolio (PSP).