As the U.S. economic engine revs up, investors are becoming more comfortable with riskier small-cap stocks, piling into high-yield business development companies and related exchange traded funds.
In 2013, investors allocated $4.1 billion to publicly traded business development corporations, the most since 2007, reports Lisa Abramowicz for Bloomberg.
“It’s going to continue to attract a fair amount of investor interest,” Theodore Koenig, chief executive officer at Monroe Capital Partners LP, said in the article. “This has been a great asset class because credit has been relatively benign.”
BDC investors are now betting on an expanding economy, which will support earnings for companies that are most vulnerable to default, while generating some attractive yields.
“The market’s realizing there’s still this pocket of money that’s getting outsized returns,” Troy Ward, a strategist at KBW, said in the article. Because few investors are able to buy the infrequently traded loans directly, “there’s not that many buckets of capital that are chasing this asset class.”
Looking ahead, Congress is looking to modify existing regulations to allow more leverage at the firms, which could boost gains, along with potential losses. The potential regulatory expansion would allow BDCs to incur more than the current limit of one dollar of debt per every dollar equity raised.
“One reason the structure has limited leverage is because you’re investing in illiquid assets,” KBW’s Ward added.
Investors can gain access to the broad BDC market through an ETF. For instance, the Market Vectors BDC Income ETF (NYSEArca: BIZD), which tracks U.S.-listed BDCs, shows a distribution yield of 6.77%. The fund has a heavier allocation toward micro-cap stocks at 49.3%, along with 24.9% in small-caps and 26.8% in mid-caps. [Making Sense of Acquired Fund Fees in BDC ETFs]
Additionally, the E-TRACS Wells Fargo Business Development Index ETN (NYSEArca: BDCS) has 12-month yield of 6.99%. Unlike ETFs, an underwriting bank backs the exchange traded note, and if the bank goes under, investors could lose their principle. The UBS E-TRACS 2x Wells Fargo Business Development Company Index ETN (NYSEArca: BDCL) provides leveraged exposure to BDCs. While the leveraged aspect exposes investors to greater risk, the ETF generated a robust 13.72% 12-month yield.
For more information on BDCs, visit our business development companies category.