Persistent inflation and rising interest rates have been at the forefront of investor concerns for most of this year.
On September 21, the Federal Reserve increased its interest rates by another 75 basis points (0.75%), continuing its fight against inflation. These rapidly rising interest rates have shaken the market, with the S&P500 down more than 24% since the start of the year.
At times like this, conservative investors are looking for safety and inflation protection. The Blackstone Secured Loan Fund (BXSL -1.39%) is a dividend-paying stock that could protect you from inflation and the effects of rising interest rates. The company has a high dividend yield and enjoys higher rates. Here’s how.
Blackstone Secured Lending Fund seeks to fill hole created by banks
Blackstone Secured Lending Fund invests in private company debt to generate income for investors. The company operates as a Business Development Corporation (BDC). BDCs finance businesses through loans and equity investments, following similar tax rules as real estate investment trusts (REITs). One such rule requires BDCs to pay out 90% of their taxable income in dividends, making them attractive high-yield stocks for income investors.
The Blackstone Secured Lending Fund sees an opportunity to meet the growing demand for credit from private companies and leverages Blackstone’s platform to identify attractive investment opportunities in private companies.
Regulation hit banks hard after the Great Recession of 2007 to 2009, and so they stopped making as much business loans. According to S&P Capital IQ LCD, US banks’ share of senior secured loans has fallen from 33% in 1995 to just 8% in 2022. The number of banks has also consolidated, leading to a shortage of private business loans .
Here’s what the company does
Under normal market conditions, the fund aims to invest 80% of its total assets in secured debt securities. The fund invests in 163 portfolio companies that have an average return of 7.8%. The fund invests primarily in senior secured loans, which make up nearly 98% of its total portfolio.
Debt investments have liens or a claim on guarantees that a company agrees to guarantee for its financing. These liens determine who gets paid first if a business cannot repay its loan. Senior secured loans have first claim on collateral, so if a business goes bankrupt, those creditors are paid off before anyone else. This can make investments safer than second lien loans or equity investments, which are less of a priority in the event of a business liquidation.
Why Blackstone Secured Lending Fund Could Be a Good Inflation Hedge
The fund’s hedging potential against inflation and rising interest rates makes it attractive. Over the past year, inflation has remained stubbornly high due to huge fiscal stimulus amid the pandemic, supply chain issues and rising housing and food costs. .
To fight inflation, the Federal Reserve is raising interest rates at a pace not seen in decades. Since March, the federal funds rate, or the rate at which banks can lend money to each other overnight, has risen from 0.25% to 3.25%.
Rising interest rates increase the yield of the Blackstone Secured Lending Fund’s debt investments, which are almost 100% floating rate instruments. These higher rates may result in higher interest charges which benefit the fund and its investors. In the first half of this year, the fund’s net investment income (NII) increased 41% from a year ago to $208 million.
In its June 30 regulatory filing, the fund noted that a 100 basis point increase would raise the NII by $73 million, while a 200 basis point increase would raise it by $147 million. Since then, the Federal Reserve has raised the federal funds rate by 150 basis points.
The risks of investing in BDC
Although rising interest rates increase the fund’s investment income, rates that rise too quickly could put pressure on these companies’ ability to repay their debts. In addition, the value of the fund’s debt securities investments could fall due to higher interest rates.
One of the ways the fund hedges this risk is by investing in these senior loans, giving it priority in the event of bankruptcy. It also spreads the risk across companies and industries, so it’s not too concentrated. Its top industries are software and healthcare providers and services, which make up 14% of its portfolio. The fund has $890 million in unused cash and debt, and 55% of that debt is fixed with an average rate of 2.97%.
Takeaway for investors
The risk of investing in the fund is that companies start defaulting in waves, leading to liquidations instead of a steady stream of income. The fund could also be squeezed if interest rates return to the lower levels we have grown accustomed to over the past decade.
Brad Marshall, Managing Director of Blackstone Secured Lending Fund, is optimistic, saying that “despite potential headwinds in the economy, we believe the outlook for shareholders is promising, given a portfolio that is well positioned for this environment and significant earnings growth potential higher rates.”
With a dividend yield of 10.4%, the company looks like a strong dividend-paying stock that could provide investors with a good hedge if inflation remains stubbornly high.