Ares Dynamic Credit Allocation Fund (ARDC): High-Yield Dividends in a Rising-Rate World—A Sustainable Bet?

The search for yield in today's low-interest-rate environment has investors turning to unconventional sources, and the Ares Dynamic Credit Allocation Fund (ARDC) has emerged as a contender with its 9.54% annualized distribution rate. But is this closed-end fund's high dividend policy sustainable, and does its strategy hold up against rising rates? Let's dissect ARDC's appeal and risks.

The Dividend Attraction: A 9.54% Yield in a Starved Market

ARDC's consistent monthly distribution of $0.1125 per share—payable through June 2025—translates to an annualized yield of 9.54%, based on its June 9 closing price of $14.15. This stands out in an environment where 10-year Treasury yields hover around 4.5%, and many traditional income vehicles offer paltry returns.

However, the fund's yield comes with caveats. Distributions are discretionary and sourced from a mix of net investment income, capital gains, or return of capital (ROC). As of June 2025, the fund trades at a 2.27% discount to its NAV ($14.22 vs. $14.55), which could either signal undervaluation or investor skepticism about future performance.

Distribution Sustainability: Leverage, Costs, and Portfolio Risks

While ARDC's dividend is tempting, its sustainability hinges on three critical factors:

1. Leverage and Costs:
   The fund employs 32.45% effective leverage (as of July 2024) via borrowings and preferred shares, amplifying returns in upswings but increasing volatility. Its 5.58% annual expense ratio—among the highest in its peer group—eats into net returns. A prolonged period of rising rates could pressure interest expenses, squeezing distributable cash flow.

2. Portfolio Composition:
   ARDC invests 80%+ in credit instruments, including senior secured loans (floating-rate), high-yield bonds, and CLO securities. These assets can benefit from rising rates, as floating-rate loans reset periodically. However, the fund's 98.10% exposure to corporate debt (as of April 2025) carries default risk, especially in a weakening economy.

3. Return of Capital Concerns:
   The fund's 2024 distributions included a significant ROC component, as disclosed in its Form 1099-DIV. If this trend continues, the 9.54% yield could erode investor equity over time.

Valuation: Discounted Price vs. NAV—A Buying Opportunity?

ARDC's 2.27% discount to NAV as of June 2025 offers a potential margin of safety. Historically, discounts for closed-end funds can widen during market stress, creating buying opportunities. However, investors must weigh this against the fund's structural risks:

• NAV Volatility: The fund's NAV dropped from $15.10 (July 2024) to $14.55 (June 2025), reflecting portfolio headwinds.
• Liquidity: With an average daily volume of ~73,500 shares, ARDC isn't highly liquid, increasing execution risk.

Capital Appreciation Potential: Rising Rates and Strategic Flexibility

ARDC's strategy is designed to thrive in rate-sensitive environments. Its dynamic credit allocation allows managers to pivot sectors and maturities to exploit opportunities. For instance, floating-rate loans—comprising a bulk of the portfolio—should perform better as rates rise, while CLO securities benefit from strong demand for collateralized debt.

Yet risks persist. A prolonged credit crunch could depress bond prices, squeezing NAV. The fund's 45% limit on CLO exposures is a prudent constraint, but high-yield defaults remain a lurking threat.

Investment Takeaways: Proceed with Caution

ARDC's 9.54% yield is compelling for income-focused investors, but it's not without trade-offs:

• Pros: High yield, diversified credit exposure, floating-rate assets.
• Cons: High leverage/costs, ROC risk, credit sensitivity, limited liquidity.

Recommendation:
- Income Seekers: Consider a small allocation to ARDC for yield, but monitor distributions post-fiscal year-end for ROC disclosures.
- Avoid: For conservative investors or those with a short-term horizon. The fund's volatility and structural risks demand a long-term view.

In a low-yield world, ARDC offers a tempting income stream, but its sustainability depends on navigating rising rates without overextending its balance sheet. Investors should proceed with caution—and a watchful eye on its NAV and distribution sources.