As investors seek out ways to augment income portfolios, business development company exchange traded funds have popped up on investors’ radars.
For instance, the Market Vectors BDC Income ETF (NYSEArca: BIZD), which tracks U.S.-listed BDCs, shows a distribution yield of 6.93%. [Making Sense of Acquired Fund Fees in BDC ETFs]
Additionally, the E-TRACS Wells Fargo Business Development Index ETN (NYSEArca: BDCS) has a current yield of 7.32%. 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 offers a robust 15.72% yield. [Investors Seeking Out BDC Stock, ETF Attractive Returns]
BDCs are high-dividend-paying firms that focus on lending senior secured loans to midsized companies. These companies act like banks to other companies, but the BDCs are not structured as banks since they pay out at least 90% of income to investors through dividends.
While BDCs handle debt instruments, many BDCs have near-zero default rates in their portfolios. By law, the companies are required to maintain low debt levels.
“BDCs tend to lend at floating interest rates while borrowing money at fixed interest rates. So their earnings would increase if floating Libor interest rates were to increase significantly,” Grier Eliasek, president of Prospect Capital, said in a Investor’s Business Daily article. “Bonds yielding fixed rates are expected to suffer losses as interest rates go up.”
Over the last five years, the BDC index has outperformed, generating 213% total return, comapred to 138% for investment-grade debt, 135% for high-yield debt, 128% for the S&P 500 index, 117% for REITs and 96% for leveraged loans.
Looking ahead, BDCs will capitalize on the more strict banking regulations. Due to new rules, banks are limited from making loans unless more than 50% of the debt can be repaid within five to seven years. Consequently, BDCs can step in and help lend to private middle-market companies.
However, Eliasek warns that many BDCs have small balance sheets with limited ability to serve as the sole lender for many companies. Additionally, they are less diversified since some companies may also lack access to investment grade debt.
S&P Dow Jones Indices recently revealed that they are launching the S&P Business Development Company (BDC) Index. While no ETF has been tied to the index yet, it may be a sign another BDC ETF is coming soon.
For more information on BDCs, visit our business development companies category.
Max Chen contributed to this article.