Invest Like Super Rich With 2 Big Dividend Stocks (ARCC & ECC)

Co-produced with Treading Softly

The biggest mistake many of us make is trying to mirror what other investors are doing without accounting for differences.

I’m going to copy Mr. super-successful’s investing so I can be super successful too!”

The flaw here is that often Mr. Super-successful often got to be super successful by investing differently than how they invest now. The concept of “keeping up with the Joneses” is wrapped up in that nicely and repainted to look different. You can’t and shouldn’t mirror the successful after their success, find and mirror HOW they got successful in the first place.

The end result is our goal, not your starting point.

This means when you hear of the super-rich investing in assets only yielding 3%-4%, they’re doing so to maintain their wealth, not grow it as they had previously. They’re comfortable where they are now. Often the fire for success wanes as it is achieved and complacency takes over.

You might want to be cautious chasing a billionaire into a space company. For them, profit is a small portion of their motive. They might not care if they lose a few billion because the first few companies fail. They’re in a position to take that risk.

I often see investors chase a big-name investor into various investments. Yet the big-name often has a fundamentally different investment. There’s a huge difference between buying a minority 5%+ stake in a company complete with a Board seat, getting your very own preferred share created, or having a substantial loan, compared to having 1,000 shares of common stock.

The bottom line is that investing with tens of millions is very different than investing with tens of thousands. Don’t rush around trying to chase some big-name investor. Focus on an investment style that fits your goals.

One thing you probably need from your portfolio that most billionaires don’t is income. How can you rapidly grow your wealth today? By growing your income stream rapidly and reinvesting your dividends as much as possible. Knowing where to find those great dividend-paying opportunities is something my team and I specialize in.

Today we want to share two great high-yield income generators that will propel your income stream to new heights. Both are intrinsically tied to the U.S. economy and its strength, meaning you are voting and believing in the U.S. economy when buying these opportunities!

Let’s dive in.

Pick #1: ECC – Yield 10.4%

Coming into 2022, we have been very bullish on funds that invest in CLOs (collateralized loan obligations). CLO funds across the board sold off when they reported drops in their NAVs as of the end of November. While several CLO funds have recovered from their decline, Eagle Point Credit (ECC) continues to trade around $14, the same price it traded for in August 2021. ECC is trading at a lower valuation than its peers. This creates a buying opportunity.

The recent sell-off in ECC started when it reported its November NAV (Net Asset Value). CLOs are portfolios of “leveraged loans,” so their prices are impacted by the price of leveraged loans. In November, loan prices sold off significantly as we can see in the S&P’s Leveraged Loan Index:

Ironically, by the time ECC reported its NAV as of Nov. 30, loan prices had already materially recovered! When we get reports on NAV, we always need to be conscious of what is being reported. NAV is always a snapshot of value at a specific moment.

Nov. 30 was the worst pricing for loans since August, and it was a dip that filled in quickly. Yet what investors saw reported was the NAV on the lowest day and that is the NAV that’s informing the decisions of many investors.

We can see that loan prices have not only recovered, they continued to push higher into January, meaning that the NAV measurement from Dec. 31 is already outdated!

This is especially noteworthy given that most debt investments came down in January. Treasuries, corporate bonds, and mortgages all went lower. Yet leveraged loans went up.

Why? Leveraged loans and CLOs are higher-yielding alternatives. With inflation picking up, the hunt for yield is on, and CLOs are floating rate investments. So if institutions believe that high inflation will cause the Federal Reserve to raise rates, then they want more exposure to floating rates and less exposure to fixed-rate debt like treasuries and bonds.

The CLO structure provides investors with a lot of flexibility to invest according to their risk tolerance. CLOs are broken into “tranches” that are sold independently. The senior tranches get first priority and have a number of protections to ensure they are paid in full even in dire scenarios. No A+ tranche has ever defaulted, making them very attractive for very conservative institutional investors. The type of investor who might own a lot of Treasuries.

The junior and equity tranches, like ECC owns, don’t get paid until the senior tranches are paid in full. They also enjoy all the upside potential if there are fewer defaults than expected. Since the CLO manager is able to sell the senior tranches at a massive premium, these tranches are a byproduct of demand for senior tranches. This is why they’re available at very cheap prices and are capable of producing extremely high yields.

With the financial system full of liquidity, default rates are at record lows.

Defaults are expected to remain rare throughout 2022, which will drive returns on CLOs even higher.

In addition to great tailwinds from macro-conditions. ECC is improving at the company level as well. Recently issuing new baby bonds at 5.375% and using the proceeds to redeem preferred equity with coupons ranging from 6.68% to 7.75%. That savings will benefit the bottom line for equity investors!

ECC will continue to see rising NAV and rising cash flow as the fundamentals for the leveraged loan market remain extremely strong, and more institutions increase their exposure to floating-rate loans.

While other investors are driving in the rear-view mirror, looking at what NAV was last month, we can buy with confidence knowing that NAV is higher right now and likely to continue growing.

Pick #2: ARCC – Yield 7.4%

Ares Capital (ARCC) is a BDC (Business Development Company) that invests in privately-owned businesses. Externally managed by Ares Management Corporation (ARES), investors in ARCC benefit from the massive reach of ARES which has $282 billion in assets under management.

84% of the companies that ARCC invests in have PE sponsors with a significant equity stake. ARCC will provide a debt investment, often combined with an equity position. As a result, approximately 77% of ARCCs portfolio is in senior secured loans that are first or second lien, with about 17% in preferred or common equity.

With an emphasis on larger private companies with an average annual EBITDA of $157 million, ARCC takes less credit risk than many other BDCs. It’s also highly diversified with an average position being just 0.3% of its portfolio and the largest single borrower being less than 1.5%. This scale means that ARCC is not going to be materially impacted by any single loan that falls apart.

However, for ARCC, a borrower running into trouble has turned into a benefit more often than a problem. The real magic of BDCs is that they’re not just a lender, they’re an investor with an interest in the success of the borrowing company. The BDC isn’t there to just lend money and run to court if it isn’t paid back, it has the ability to become actively involved in the business and use its resources to turn things around in a way you just won’t see from banks.

ARCC has taken this difference to heart and has routinely realized large gains from restructuring, buyouts, equity positions, and other gains. Over time, this has added over $1 billion in net realized gains after realized credit losses:

As with all lenders, ARCC does its best to lend to those who will pay it back, but going through the Great Financial Crisis and then COVID, the reality is that some borrowers will hit tough times. Working out profitable alternatives is one of the things that ARCC does better than any other BDC. Its talented team and connection with ARES play a large role in that.

As investors, we can count on ARCC to invest in companies that will do well, and better yet when the unexpected happens and they are behind in the fourth quarter, ARCC is the team you can count on to run a flawless two-minute drill and bring home the win.

The current environment is great for BDCs. ARCC recently demonstrated it can still access cheap capital, issuing new 2.875% Notes due 2027. It followed that up by issuing 10 million shares of common stock at a premium to book value. This tells us two things: First, ARCC can still access cheap capital. The less ARCC pays for its capital, the more money there is to come to us!

Second, it tells us that ARCC has been busy the past few months as just a couple of months ago ARCC issued $700 million in debt. ARCC is obviously finding plentiful investment opportunities, which is what we were predicting last year. A larger portfolio means larger returns for shareholders!

Conclusion

I don’t ever expect to become Mr. Super-Successful, I’m too shy to draw that much spotlight to myself. I like a quiet life, with family and friends. However, I would greatly enjoy having an income stream, from my investments, that matches or beats Mr. Super-Successful’s income stream. Wouldn’t you?

When retirement arrives, much of our lives have passed. I want your retirement to not be spent chasing the lifestyle of another, or misunderstanding that what gets people places isn’t always how they stay there. Instead, we need to be mindful of the recipe for success before we learn the recipe to stay wealthy. One is offense, the other is defense.

In the end, most of us simply want a life where worrying about finances is not a concern we must have. That can be achieved through successful income investing. These two opportunities can help you start generating outstanding income today, and enjoy them for years to come.