Hailing from the alternative asset universe, business development companies (BDCs) have increased in popularity among investors for one big reason: Tantalizing dividend yields. However, with Treasury yields on the rise, some high-yielding asset classes are proving vulnerable, meaning investors should take the time to assess positions in BDCs and the corresponding exchange traded funds.
BDCs re closed-end investment companies created under the Investment Company Act of 1940 that invest in debt and equity of small public and privately held companies. The companies essentially help fund small $5 million to $100 million businesses. Ever since the financial crisis, regulators have clamped down on traditional lenders and made it harder for businesses to access public capital, which has forced smaller business to take loans from BDCs.
Since the debt is typically senior secured and set to float with interest rate benchmarks, there is diminished rate risk. When the Fed raises rates, BDC loan interest rates pegged to the London Interbank Offered Rate, or LIBOR, will also rise. [BDC ETFs for a Growing Economy, Attractive Yields]
The $83.9 million Market Vectors BDC Income ETF (NYSEArca: BIZD), which carries a whopping 30-day SEC yield of 8.6%, is one of the more notable BDC ETFs.
“Although yields of that sort may be especially tempting in our low interest rate environment, there is no free lunch. We find that current yields are at particular risk from an increase in interest rates and competition for suitable investment targets,” according to a recent note from AltaVista Research. http://altavista-research.com/