Co-authored by Treading Softly.
I've always enjoyed reading and analyzing good literature. One of my favorite short stories is the story of the Great Carbuncle, which tells the adventure of various people looking for this great shining gem, all with different purposes. Some wanted to sell it and make a large profit; others wanted to examine it and publish their findings to discover fame. Everyone was looking for this great carbuncle, and in the end, a couple who were happy not having it were the ones who ended up discovering it.
When it comes to the market, investors will often spend their entire lives looking for their equivalent of the great carbuncle. For some, it'll be something as magnificent as trying to find the next Netflix (NFLX), Amazon (AMZN), or Nvidia (NVDA). For others, it's finding that one niche company that will help them finish filling out their portfolio. For me, the greatest find would be the one that allows my portfolio to achieve the continued success that it's already seen. I'm an income investor, and I scour the market looking for outstanding income opportunities that are at cheap valuations and provide high yields.
Today, I want to present two opportunities that I have found that I think are well worth holding in your portfolio. The beautiful thing about my portfolio is that I'm not looking just for one holding. I plan to hold at least 42 at the bare minimum.
Let's dive in!
Pick#1: OBDC – Yield 9.8%
Blue Owl Capital Corporation (OBDC) is the third largest BDC (Business Development Company) by net assets. On February 21, OBDC reported its Q4 and full-year financial results.
OBDC ended FY 2023 with 193 portfolio companies, with an average EBITDA of $204 million. 82% of the BDC’s investments were senior secured loans, 68% were first lien investments, and the portfolio carried a weighted average Loan-To-Value ratio of 44%. Most importantly, 97% of the portfolio was floating-rate loans, and OBDC’s portfolio net interest margin soared to 12.4% (up from 11.5% in December 2022), positioning the BDC well for a higher-for-longer scenario. Source.
OBDC’s Q4 NII (Net Investment Income) per share of $0.51, a record for the company, fueling a $0.08/share supplemental dividend for the quarter. As such, OBDC paid $0.43/share in total Q4 dividends, and $1.59 for FY 2023 (a 25% YoY increase). OBDC also increased its Q1 2024 regular dividend by $0.02 to $0.37/share, reflecting a 9.8% annualized yield (before adding in the $0.08 supplemental announced for Q1).
OBDC reported a relatively similar portfolio risk rating as Q3, with 89.1% of the portfolio performing as or better than expected. Four portfolio companies were in nonaccrual status, and 0.5% of the portfolio was in delinquent status (up from 0.1% in Q3)
OBDC maintains an investment-grade “BBB-” credit rating with largely fixed-rate debt. As such, the BDC was able to grow its top line while maintaining its expenses steady, fueling dividend raises and special dividends through the hawkish rate cycle.
At the end of FY 2023, OBDC reported $2.1 billion of liquidity in cash and undrawn debt, with a debt-to-equity of 1.09x, well within the BDC’s target range of 0.90x – 1.25x. As banks are increasingly risk-agnostic amidst market uncertainty, OBDC’s leverage and liquidity position provides room to fill the rising demand for capital in a weakening economy.
OBDC’s weighted average debt maturity of approximately 5.1 years, positioning the BDC well to withstand higher rates for a longer timeframe while delivering large dividends to shareholders.
For a blue-chip BDC of OBDC’s standings, with excellent credit quality, liquidity position, portfolio composition, and book value growth, the company deserves to trade at a healthy premium to NAV. Instead, it trades at a ~3% discount, making it an excellent bargain to buy into.
Pick#2: HQH – Yield 11.4%
abrdn Healthcare Investors (HQH) is a CEF (Closed-End Fund) formerly known as "Tekla Healthcare Investors." Aberdeen bought out Tekla and now has ownership of the healthcare funds that Tekla managed. Aberdeen made it clear that the same team that had been managing the funds would remain in place and so far has lived up to that promise. This makes sense because getting the expertise of the Tekla team was a major incentive for the acquisition.
However, abrdn is making some changes to the fund. One major change is the distribution policy. HQH previously distributed 2% of NAV each quarter, based on NAV on the last trading day of the quarter. The new policy will be to distribute 2.5% of the average daily NAV for the previous three months.
The bottom line is that Aberdeen is providing HQH investors with a significant raise. The Q1 distribution will be $0.48, compared to $0.38 in the prior quarter. Currently, HQH is on track to pay an even higher distribution for Q2.
It is important to note that a change in distribution policy does little to influence a CEF's total return on NAV. If HQH is paying out more distributions, then NAV will be lower than it would be if it retained that cash.
However, NAV is only one component of investor return. One reason Aberdeen might have chosen to make this change is that HQH has been trading at a discount to NAV. For $16.72, you are buying $19.58 in assets (prices as of March 5 market close):
By distributing more, Aberdeen might believe that this discount to NAV will shrink. For investors who are buying now, this means some potential upside. If that upside doesn't materialize, our dividends are calculated based on NAV, not market price. So we will be getting a 9.8% yield based on NAV, which is $19.58, but effectively yielding 11.4% since we are only paying $16.72!
HQH's focus is on biotechnology and pharmaceuticals, which make up nearly 80% of its portfolio combined. Source.
This is a sector that is a powerhouse that will continue seeing demand increase. HQH provides us the opportunity to gain exposure to this sector while receiving a generous distribution.
Will HQH's new distribution policy close the discount to NAV? I don't know. What I do know is that more money coming into my pocket gives me the option to reinvest in HQH, invest elsewhere, or do the one thing that makes financial advisors more upset than anything – I might spend it!
Conclusion
With OBDC and HQH, I can enjoy solid income at cheap prices. Both trade at a discount to NAV/Book value and have strong outlooks. This allows me to get my income on the cheap while not having to worry about overpaying for something that's going to be paying me back quarter after quarter.
When it comes to retirement, there isn't a great carbuncle for you to go find. The biggest mistake many make when they're saving for retirement is expecting that they just need a single million dollars and they'll be financially set. But it may come as a surprise that when you retire, no one comes to you looking for a check for $1,000,000 claiming that they'll take care of you for the rest of your life. It's just not how it works. Instead, you need to have income. Do you have to pay your expenses? You're going to have bills. You need to have cash to pay them somehow. I can use great holdings like HQH and OBDC to be able to pay my bills and have extra left over to reinvest to grow my income in the future.
That's the beauty of my Income Method. That's the beauty of income investing.
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