Against the backdrop of rising Treasury yields, plenty of income-generating asset classes and sectors have struggled this year. However, 2016 could bring better things for business development companies (BDCs) and the Market Vectors BDC Income ETF (NYSEArca: BIZD) even if the Federal Reserve proceeds with boosting interest rates.
BDCs offer attractive income opportunities since they are required to pay out 90% of income in form of dividends, a structure similar to what income investors find with real estate investment trusts (REITs).
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. [BDC ETFs for a Growing Economy, Attractive Yields]
“We believe the market has more than adequately priced in the expectations for further credit issues , and consensus earnings estimates have already been adjusted for limited fees and slower portfolio churn. In addition, the market perception that rising interest rates are bad for yield investments is fully priced into the shares, in our opinion, and these fears could subside if rates be gin to rise and investors realize that earnings will not be materially affected and that the current high stock yields are attractive even if rates increase. Bottom line, short of an economic recession, we believe most of the headwinds for the BDC group are already priced into the shares and the group is ripe for a bounce,” according to a Keefe, Bruyette & Woods note posted by Amey Stone of Barron’s.
Investors have embraced BDCs for their attractive yields as they are required to pay out at least 90% of interest income received in cash dividends. BDCs act as an alternative to bank loan debt, helping smaller companies grow and profiting off the investments. In an expanding economic environment, BDCs should also benefit from stronger domestic businesses. Additionally, since the debt is typically senior secured and set to float with interest rate benchmarks, there is diminished rate risk.