Investors looking for alternative asset classes with eye-catching yields may want to consider business development companies (BDCs), which are accessible in exchange traded funds like the VanEck Vectors BDC Income ETF (NYSEArca: BIZD).
BIZD gets down to business by seeking to replicate as closely as possible, before fees and expenses, the price and yield performance of the MVISÂ® US Business Development Companies Index. The fund normally invests at least 80% of its total assets in securities that comprise the fund’s benchmark index.
“Similar to REITs, BDCs are regulated investment companies (RICs) required to distribute more than 90% of their profits and gains to shareholders, avoiding corporate income taxes before distributing to shareholders. This structure prioritizes income to shareholders (over capital appreciation), driving higher yields that currently range from around 7% to 13%,” reports Seeking Alpha.
BDCs Well-Positioned for a Pandemic
Business development companies (BDCs) have increased in popularity among investors under the Federal Reserve’s low interest rate policy because this asset class is known for its whopping yields.
BIZD components 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.
BDCs act as an alternative to bank loan debt, helping smaller companies grow. They profit off of the investments, which in turn 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 and low interest rates.
Of course, with big yields come other factors for income investors to consider.
“There are many factors to take into account when assessing dividend coverage for BDCs including portfolio credit quality, potential portfolio growth using leverage or equity offerings, fee structures including ‘total return hurdles’ taking into account capital losses, changes to portfolio yields and borrowing rates, the amount of non-recurring and non-cash income including payment-in-kind,” notes Seeking Alpha.
BDCs are also seen as sensitive to higher interest rates, but that situation may be overstated as well. Since the debt is typically senior secured and set to float with interest rate benchmarks, BDCs may have diminished rate risk. When the Fed raises rates, BDC loan interest rates pegged to the London Interbank Offered Rate, or LIBOR, will also rise.
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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.