The song remains the same, and it will for the foreseeable future. The Federal Reserve probably will not raise rates until 2023, so we remain in a setting with coupons on government securities still close to generational lows. Certificates of deposit at banks are wretched, with the best five-year rate we could find at a paltry 1.25%. Quality investment-grade corporate and municipal bonds? Same story.

So what are balanced growth and income investors to do? The potential for capital appreciation on low-coupon bonds is negligible, and with the market possibly primed for a big sell-off, risking high-yield or leveraged funds doesn’t make any sense for those with low risk tolerance. What does make sense is looking at the business development stocks that pay outsized dividends and offer growth potential.
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Business development companies are organizations that invest in small and medium-sized companies, as well as distressed companies. These so-called BDCs help the small and medium-sized firms grow in the initial stages of their development. With distressed businesses, the BDC helps the companies regain sound financial footing.

A new Truist Securities research report features a deep dive into BDCs, and the firm is reasonably positive on the group going forward. While the stocks are better suited for investors with a larger risk tolerance, the income generated can be well worth it. The report said this:

We anticipate 2021 could be the best new origination pricing environment since the end of the 2008 financial crisis, but have concerns regarding the state of the economy and loan activity. That said, we believe conditions are ripe for BDCs with scale, size and financial capacity to fuel investment growth through 2021. Our analysis suggests the majority of BDCs under coverage have ample liquidity and capacity for new investments.

Four top BDC companies are the favorite picks at Truist, and all their stocks are rated Buy. It is important to remember that no single analyst report should be used as a sole basis for any buying or selling decision.

Ares Capital

Ares Capital Corp. (NASDAQ: ARCC) is a leading specialty finance company that provides one-stop debt and equity financing solutions to U.S. middle market companies, venture capital backed businesses and power generation projects. Ares Capital originates and invests in senior secured loans, mezzanine debt and, to a lesser extent, equity investments through its national direct origination platform. The company’s investment objective is to generate both current income and capital appreciation through debt and equity investments primarily in private companies.

Top Wall Street analysts believe the strength of the company’s origination platform, sizable balance sheet and ample liquidity position it favorably in a very competitive investing environment. Some believe that with the current tight spread environment Ares Capital has the scale and industry relationships to continue to make competitive, high-credit-quality investments. The Truist team agreed and said this:

Despite the intense competitive environment and continued economic uncertainty due to the COVID-19 fallout, we believe the tailwinds from incremental leverage (aided by the company’s scale and reach) should benefit net investment income growth and provide a comfortable cushion between earnings and dividends beginning in 2021. The company’s healthy realized gains keep its overall taxable income well in excess of its $0.40 regular dividend with a spillover of $410 million or $0.96 per share (as of September 30, 2020).

Investors receive an 8.84% dividend. The Truist price target for the stock is $18, which compares with a $17.43 Wall Street consensus target. The stock was last seen trading on Friday at $18.109.

This is a very well-known name on Wall Street, and it offers a solid entry point at current levels. FS KKR Capital Corp. II (NASDAQ: FSKR) specializes in investments in floating rate, senior secured loans-first lien and second line, senior secured bonds, subordinated debt, collateralized securities, corporate bonds, debt securities, equity such as warrants or options in middle-market private companies. The fund does not intend to invest to any significant degree in start-up companies, turnaround situations or companies with speculative business plans.
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It seeks to invest in various sectors such as consumer services, energy, capital goods, software and services, telecommunication services, consumer durables and apparel, diversified financials, materials, automobiles and components, commercial and professional services, media, technology hardware and equipment, health care equipment and services, insurance, retailing, transportation, pharmaceuticals, biotechnology, and life sciences, food and staples retailing, food, beverage, and tobacco, household and personal products, real estate and utilities.

The analysts are very positive and noted this:

The company has the potential to offer solid returns with: (1) a relatively low risk profile to shareholders based on its focus at the top of the capital structure; (2) emphasis on companies at the higher-end of the middle market spectrum; and (3) typical position as the sole lender, controlling the covenants, and able to write large checks.

Shareholders receive a stunning 12.5% dividend. Truist has a price target of $19, and the consensus target is $18. The last trade for Friday hit the tape at $17.86 a share.

Owl Rock Capital

Shares of this off-the-radar company have traded sideways for almost a year and could have breakout potential. Owl Rock Capital Corp. (NASDAQ: ORCC) is a specialty finance company that invests in debt and equity of middle-market commercial enterprises.

The company’s objective is to generate current income with the potential for capital appreciation for distribution to shareholders as dividends. The company principally underwrites floating-rate credit structures at the upper end of the capital structure.
The analysts are very positive on the shares and noted this:

The company has an impressive management team and built a portfolio that fits well in the current credit environment, in our opinion. Looking ahead, we believe there is opportunity for multiple expansion as Owl Rock improves on its solid financial performance.

Investors receive a 9.16% dividend. The $15 Truist price target is greater than the $13.80 consensus target. The most recent closing share price is $13.54.
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Sixth Street Specialty Lending

This is a lower yielding player, but the quality portfolio makes it a better fit for more conservative investors. Sixth Street Specialty Lending Inc. (NYSE: TSLX) invests in debt and equity of middle market commercial enterprises. The company’s objective is to generate current income with the potential for capital appreciation for distribution to shareholders as dividends.

With over $50 billion in assets under management and more than 320 team members, including over 145 investment professionals in nine global locations, Sixth Street has a track record of providing differentiated, creative solutions to companies and management teams around the world. The company has nine diversified, collaborative investment platforms and flexible, long-term capital base allow us to invest thematically and without constraints across sectors, geographies and asset classes.

The growing net asset value and a strong portfolio make this company a favorite at Truist. The report said this:

TPG has earned its premium multiple to book as it consistently out-earns the dividend, generates gains on portfolio exits (due to its embedded call protection packaged in almost every loan) and pays investors variable dividends rewarding investors for net investment income upside. We believe there is still a possibility for multiple expansion, should its strong track record of outperformance continue through the year.

Shareholders receive a 7.55% dividend. Truist Securities has set a $22 price target. The consensus target is $21.40, and shares closed on Friday at $21.72.

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While the Truist Securities price targets are not sky-high, combined with the strong dividends, the total return possibilities for all of these stock look to be very solid. Given that BDCs also have been somewhat out of favor, the risk-reward also looks compelling.

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