Macroeconomic Headwinds:

Another big risk facing the BDC industry is a general economic slowdown. Because BDCs generally lend to higher risk smaller businesses, they are often the most negatively impacted if/when the economy turns south. However as mentioned previously, Saratoga has very high lending quality standards (no loans are in non-accrual). Plus, we may see higher infrastructure spending and lower taxes from the new administration which could help the economy in general.

External Management Team:

Even though most publicly traded BDCs are externally managed, this still presents potential conflicts of interest. One such conflict of interest/risk is higher expense ratios, of which Saratoga (externally managed) is not immune, as shown in the following chart.

However, a large part of the reason the expense ratio is high is because Saratoga is small relative to other BDCs, and this creates few economies of scale. As Saratoga continues to grow, the fixed costs will shrink as a percentage and the expense ratio will come down. Also worth noting, approximately 24% of Saratoga’s shares are owned by management, and an additional ~13% are owned by non-management insiders. This helps to align the interests of the external management team with shareholders.

Conclusion:

Over the last six years, Saratoga Investment Corp (NYSE:SAR) has evolved from a high risk company to a relatively lower risk company with a healthy, growing dividend. Despite its strong year-to-date stock price performance, its valuation remains relatively attractive, as measured by its discount to NAV, healthy NII, and strong ROE. Further, it has several competitive advantages and may be less exposed to the risks faced by other BDCs. We don’t currently own shares of Saratoga, but we’ve added it to our Blue Harbinger watch list, and may consider a future purchase should the shares show any significant weakness.

Note: This article was written by Blue Harbinger. At Blue Harbinger, our mission is to help you identify exceptional investment opportunities while avoiding the high costs and conflicts of interest that are prevalent throughout the industry. We offer additional free reports and a premium subscription service at BlueHarbinger.com. If you are ever in the Naperville, IL, USA area, our founder (Mark D. Hines) is happy to meet you at a local coffeehouse to talk about investments. Please feel free to get in touch.