The Ares Capital Dilemma: Worth the 8.5% Yield?

Looking at Ares Capital today, I’m struck by one thing above all else - it’s a Business Development Company (BDC) offering an eye-popping 8.5% dividend yield. But before you rush to add this to your portfolio, we need to examine what’s really happening beneath the surface.

As a BDC, Ares essentially functions as a lender to small businesses that lack access to traditional financing options. While this creates opportunity, it also introduces significant risk. These smaller clients often can’t secure bank loans or access capital markets, forcing them to accept Ares’ steep lending terms - often around 10% interest.

I’ve always found the BDC model somewhat predatory. These small businesses face an uphill battle with such high interest rates, making profitability more challenging. What’s worse, nearly 70% of Ares’ debt comes with floating rates. When interest rates climb, their clients face even greater financial pressure.

The dividend history tells a troubling story. During the 2007-2009 Great Recession, Ares slashed its dividend dramatically. This isn’t just a company-specific issue but an inherent flaw in the BDC business model. Even well-managed BDCs like Ares can falter precisely when investors most need stability.

Yes, Ares has diversified across 560+ companies, and its first-lien position on nearly 60% of its loans provides some protection. But the fundamental problem remains - when rates rise, clients struggle to pay; when rates fall, Ares’ income drops. Either scenario threatens the dividend.

For all the talk about Ares being “well-respected,” the volatility in its dividend payments should give any serious income investor pause. The BDC model creates a lose-lose scenario that even skilled management can’t entirely mitigate.

If you’re seeking reliable income rather than just chasing yield, Ares Capital might disappoint you at the worst possible moment. The 8.5% yield looks tempting, but remember - higher yields typically signal higher risk, and in this case, that warning certainly applies.