After years of expanding credit, some investors are growing concerned over business development companies. However, the sector and BDC-related exchange traded funds may still have a couple of good years left in them.
Oppenheimer & Co. analysts argue that it is too early to “cry wolf” about BDCs as more investors are concerned about the duration of the current credit cycle, reports Amey Stone for Barron’s.
“Historically expansions of credit have averaged about nine years, suggesting a few more to go … This expansion if anything should be longer than average because the 2007-09 contraction was so violent… Other than with the exception of the energy sector, our outlook is that asset quality is likely to remain good for several years to come,” according to Oppenheimer’s lead analyst Chris Kotowski.
Kotowski also estimated that share are trading at an average discount, or 95% of net asset value. Oppenheimer currently holds a outperform rating on 10 BDCs, including Alcentra Capital (NasdaqGS: ABDC), American Capital Senior Floating (NasdaqGS: ACSF), CM Finance (NasdaqGS: CMFN), Capitala Finance (NasdaqGS: CPTA), Fidus Investment (NasdaqGS: FDUS), Garrison Capital (NasdaqGS: GARS), Monroe Capital (NasdaqGS: MRCC), New Mountain Finance (NYSE: NMFC), Stellus Capital Investment (NYSE: SCM) and TCP Capital Corp (NasdaqGS: TCPC). The analysts also project an opportunity for 16% total returns, with a 9.6% average yield, in the BDCs.
Investors who are seeking a diversified position in BDCs can also take a look at the exchange traded fund option, the Market Vectors BDC Income ETF (NYSEArca: BIZD). Additionally, the exchange traded note UBS E-TRACS Wells Fargo Business Development Index ETN (NYSEArca: BDCS) and the leveraged UBS E-TRACS 2x Wells Fargo Business Development Company Index ETN (NYSEArca: BDCL) also provide exposure to BDCs. [BDC ETFs for a Growing Economy, Attractive Yields]
BDCS includes a 0.6% tilt toward ABDC, 0.5% in ACSF, 0.3% in CMFN, 0.7% in CPTA, 0.9% in FDUS, 0.7% in GARS, 0.5% in MRCC, 2.8% in NMFC, 0.6% in SCM and 2.9% in TCPC. BIZD holds 3.9% in NMFC and 3.8% in TCPC.
BIZD has a 8.29% 12-month yield. BDCS has a 8.02% 12-month yield and BDCL shows a 17.86% 12-month yield.
Business development companies, or BDCs, are 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.
For more information on BDCs, visit our business development companies category.
Max Chen contributed to this article.