Years of depressed interest rates on government bonds are sending income investors scrambling, with many embracing alternative sources of yield, including business development companies (BDCs).
Known for high yields, BDCs make loans to small and medium enterprises, many of which carry junk credit ratings. As such, many can’t land financing from traditional lenders, and BDCs can command premium interest rates on the loans they extend to these companies.
For investors looking to get in on this asset class while eschewing stock picking, the VanEck Vectors BDC Income ETF (NYSEArca: BIZD) is the way to go. BIZD debuted eight and a half years ago as the original BDC exchange traded fund. Today it’s a thriving income destination with $461.5 million in assets under management and an eye-catching 30-day SEC yield of 8.11%.
While that yield will get many investors in the door, some still have questions about the intricacies of this asset class.
“BDCs generate income by lending to and investing in these businesses using a variety of sources, such as equity, debt, and hybrid financial instruments,” notes VanEck product manager Coulter Regal. “In short, BDCs provide capital to small businesses, and in turn, give investors access to the growth and income potential of private companies that are generally exclusive and difficult to access.”
Home to 25 BDCs, BIZD isn’t as vulnerable to rising rates as some other high-yield asset classes. In fact, because many BDCs have floating rate components in their loans, the asset class has an enviable history in rising rate environments.
Likewise, rising Treasury yields play out similarly for BDCs as they do for banks because, like banks, net interest margins are important metrics for BDCs. Those margins are positively correlated to 10-year yields.
While all this sounds compelling (it is), particularly with rates seemingly having nowhere to go but up, some investors are likely to question BIZD’s expense ratio of 10.23%, which translates to $10.23 per $100 invested. VanEck’s Regal addresses that issue.
“BDCs, like all publicly traded companies, have operating expenses, such as payroll and real estate expenses,” said the VanEck analyst. “Additionally, many BDCs are externally managed, and the external management company will typically charge a management fee, and sometimes incentive fees, to the BDC. Due to an SEC rule addressing funds of funds (such as BIZD), there is a requirement for a fund of funds to report a total expense ratio in its prospectus fee table that accounts for the expense ratios of the underlying funds, including BDCs, in which it invests as an expense item called acquired fund fees and expenses (AFFE).”
Fortunately, AFFEs aren’t accrued daily, nor are they paid from BIZD’s assets. It’s expected that the actual expense ratio BIZD investors will see is 0.40%.
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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.