With many considering various ways to diversify their an income-generating portfolio in a changing market environment, investors may look to business development companies and related exchange traded funds as an alternative to traditional fixed-income assets and to enhance yields without piling on interest rate risk.
“At the same time that rising interest rates are weighing on income investors, the desire for yield persists,” Meredith Larson, Product Manager of ETFs at VanEck, said in a note. “However, investors have options without the meaningful interest rate duration found with traditional fixed income investments, and BDCs are one of those options.”
For example, the VanEck Vectors BDC Income ETF (NYSEArca: BIZD) tries to track the performance of the MVIS US Business Development Companies Index, which is comprised of publicly traded BDCs.
BDCs may offer a competitive risk-to-return tradeoff, compared to high-yield bonds, leveraged loans and equities across the market capitalization spectrum, Larson said. Additionally, they come with attractive yields, historically averaging about 8.7%. BIZD currently shows a 12-month yield of 8.12%. However, potential investors should keep in mind that these high yield levels are an indicator of potential credit risk.
Business development companies generate attractive yields since they are required to pay out 90% of income in the form of dividends. This is a structure similar to what income investors find with real estate investment trusts, or REITs.