Business development companies (BDCs) are typically higher yielding securities and the search for income is one catalyst behind the ascent of the VanEck Vectors BDC Income ETF (NYSEArca: BIZD), which is higher by almost 26% over the past year.
BIZD tries to reflect the performance of the MVIS US Business Development Companies Index, which includes publicly traded BDCs. The ETF has a tempting 30-day SEC yield of over 9%. Business development companies generate robust yields since they are required to pay out 90% of income in the form of dividends, a structure similar to what income investors find with real estate investment trusts, or REITs.
While BIZD’s yield is certainly noteworthy, investors should thoroughly examine the current environment for BDCs before rushing into this asset class.
“A more favorable funding environment and improved equity valuations could lead to improved funding flexibility for some US business development companies (BDCs) in 2017, says Fitch Ratings. Stronger BDCs are likely to become more opportunistic issuers this year as market factors could enhance the attractiveness of issuing unsecured debt. Other challenges remain, however, and Fitch maintains a negative sector outlook,” said Fitch Ratings in a recent note.
BDCs should also do relatively well in the kind of environment where many expect an increase in interest rates. Since BDC loans are mostly floating rate, the companies could earn more as rates rise.
“Market access for BDCs is likely improving due to a mix of increased interest rates supporting net interest income, greater stabilization in the group’s energy exposures, right-sizing of some dividends, some adjustment in their external management fees and incentive income, and stronger deal flow heading into 2017,” said Fitch.
Although investors are often faced with the prospect of paying up on valuation for higher yielding asset classes, that is not necessarily the case with BIZD. The ETF sports a price-to-earnings ratio of just under 15, which implies a notable discount to the broader universe of U.S. stocks.
“BDC equity valuations have also benefited from these dynamics with the average share price discount to book value for Fitch-rated BDCs improving to 1.3% as of January 13, up from a discount low of approximately 25% in early 2016,” adds Fitch.