What’s Happening to Closed-End Funds as Interest Rates Remain Low?
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.
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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.
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.
Continue to the next part for a look at who’s paying the most in dividends.