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Why Closed-End Fund Managers Are Targeting Originations in 2016

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Part 5
Why Closed-End Fund Managers Are Targeting Originations in 2016 PART 5 OF 10

What’s Happening to Closed-End Funds as Interest Rates Remain Low?

Deploying leverage

Closed-end funds have taken advantage of ultra-low interest rates inside and outside the United States in order to earn spreads by deploying capital in asset classes that yield higher returns. Ares Capital’s (ARCC) net DE (debt-to-equity) ratio of 0.77x is thus in line with the average target of 0.65x–0.75x set by its management. The company is focusing on lowering its cost of debt and maintaining a prudent maturity level for its debt and diverse sources of capital.

What&#8217;s Happening to Closed-End Funds as Interest Rates Remain Low?

What&#8217;s Happening to Closed-End Funds as Interest Rates Remain Low?

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BlackRock Capital Investment (BKCC), by comparison, commands a premium in valuations, mainly due to lower leverage. The market sees this as safe because interest rates are expected to rise, and the company has a net leverage of 0.47x. The earning power of its investment portfolio and its low leverage puts the company in a strong position for the next few quarters.

Higher returns

Prospect Capital (PSEC) continues to make use of leverage to generate higher returns. The company’s fiscal 3Q16 net debt-to-equity ratio fell to 73.8% from its fiscal 4Q15 debt-to-equity ratio of 77.6%. This was mainly due to its repayment of $58 million of its revolving line of credit during the quarter.

Prospect Capital still has significant unencumbered assets, matched book funding, access to diversified funding markets, and an unsecured fixed-rate liability focus. The company is looking at spin-offs and at increasing leverage as sources for raising capital. More leverage should allow Prospect Capital to generate a higher return for its equity holders.

Reducing the cost of debt

Closed-end funds (PEX) are replacing their existing debt to reduce the effective rate of interest. Prospect Capital’s cost of debt is approximately 5.4%, compared to the more than 6% it saw one year previously. It achieved this reduction by repaying certain higher-cost debts and by using its revolving credit facility efficiently.

TPG Specialty Lending (TSLX), American Capital (ACAS), and United Rentals (URI) are also working on reducing their cost of debt to improve their net margins.

Continue to the next part for a look at who’s paying the most in dividends.

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