Small PE Companies: High Yield Exposure to Smaller Companies: Blackrock Kelso Capital Corp. (BKCC)

These firms invest in smaller private companies, generally with up to $1 billion in market cap.  It is nearly impossible for average investors to gain direct exposure to private companies, especially smaller ones.  These firms use a variety of instruments to invest, such as senior secured loans, secured notes, subordinated debt, equity investments, and sometimes options.  Often these firms have investments in 40 to 50 different companies, so they are diversified in case an investment loses value.

Several of these PE firms highlight that the size of companies they invest in are ideal buy-out targets for larger companies and PE firms.  Any buyout of their investments could result in a higher return or earlier cash flows for the firm.

Also, management of these companies takes into account diversification across industries.  I prefer companies with at least 40 different investments in different industries which provides a broad base and helps absorb industry, regional, or company specific shocks.  Below is a figure from the Blackrock Kelso quarterly report, showing their investments by sector.

As a result of this broad diversification amongst smaller US companies, the health of each company’s portfolio is highly correlated to the US economy.  As the US economy improves, the companies these firms invest in will do better, resulting in more profitable investments.

Generally, there are few analysts covering these stocks.  Since there are few analyst opinions to rely on, it is best to look at the track record of each company’s management.  Their track record will show how well they pick and manage investments over the long term and in particular, how well they performed through the recent financial crisis.  The past 5 or 6 years give potential investors a good sample of how managers performed in a variety of market conditions.  Nearly all of these companies’ charts show that they took a significant hit during the financial crisis but many leveled out quickly after that.

I think that small BDC’s such as Blackrock Kelso will turn out to be good low-beta investments over the next several years as the economy continues to improve due to their strong dividend and proven track record.

The article Small PE Companies: High Yield Exposure to Smaller Companies originally appeared on Fool.com and is written by Adam Jones.

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