In a challenging income environment, investors should consider assets beyond common stocks and bonds. One idea to mull is business development companies, which are accessible via the VanEck Vectors BDC Income ETF (NYSEArca: BIZD).
BIZD yields almost 12.10%, which is tempting in any environment, but even more so these days. BIZD’s big yield is undoubtedly tempting, but their investors should perform due diligence. Business development companies and related ETFs have been hammered on fears of increased loan defaults in the wake of the coronavirus pandemic, but the sector has surged as aggressive stimulus measures help support the beleaguered sector and the lower-for-longer yield environment attracts income-minded investors.
BDCs “offer high income potential and may be an attractive option for investors looking to boost yield and diversification in their portfolio,” said VanEck in a recent note. “While this segment of the market was hit hard in March and April, recent earnings calls by BDCs offered valuable insight into the health and outlook of the middle-market space that may point to a continued recovery going forward.”
BDCs are comprised of companies that fund small- to mid-sized private companies, which are usually rated below investment grade or not rated at all – these companies would find it harder to acquire traditional means of loans, so they turn to outside sources of capital. Since the financial crisis, regulators have clamped down on traditional lenders, making it harder for many businesses to access public capital.
“One important theme discussed was the increased demand for customized financing needs, particularly as traditional banks have been less aggressive in seeking to make new loans. This may provide an opportunity for BDCs to capture better terms, pricing, and documentation on new investments going forward. Also discussed was the topic of interest collection and nonperforming loan rates,” notes VanEck.
Many of these private smaller businesses turned to loans from BDCs as an alternative. BDCs act as an alternative to bank loan debt, helping smaller companies grow and profiting off the investments, which in turn would then help investors gain exposure to the growth and income potential of these privately held companies. In an expanding economic environment, BDCs should also benefit from stronger domestic businesses.
Declining non-accruals and rising collection rates could “indicate that investment income for much of the BDC market has, so far, not been materially impacted by the pandemic, which we believe should help alleviate concerns of deteriorating BDC distributions. While BDCs are still trading below pre-pandemic levels, these insights from quarterly earnings may suggest that they are recovering and could continue to produce attractive income for investors,” according to VanEck.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.