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 its total assets in securities that comprise the fund’s benchmark index.
While yields on this asset class are tempting, investors should be selective, an objective BIZD helps them accomplish.
“Income investors may want to pay attention to business development companies’ earnings this month: Those that report stable loan portfolios could deliver some healthy yields,” reports Alexandra Scaggs for Barron’s. “The vehicles, known as BDCs, are among the only ways that individual investors can lend to midsize companies that are too small for traditional bond offerings. BDCs generally raise money in both equity and bond markets and lend to those companies directly, or buy their loans.”
Breaking Down This High-Yield Class of Assets
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.
“BDCs, however, often lend at floating rates. That means that if short-term U.S. interest rates eventually rise, those loans’ interest rates will rise, as well. That might be years away, but it does help investors dodge risk of paper losses that hit fixed-rate bonds when yields rise,” according to Barron’s.
These investment vehicles 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, there is diminished rate risk in these sorts of investments. When the Fed raises rates, BDC loan interest rates pegged to the London Interbank Offered Rate, or LIBOR, will also rise.
“There are still a few factors that could work in BDCs’ favor from here, however. Perhaps the biggest is a rally in risky debt that has pushed yields on low-rated bonds lower. Bonds rated CCC+ or below—the lowest-rated bonds not in default—have rallied 2.4% for the year through Wednesday, according to ICE Indices. That outperformance may bode well for BDCs, seen as one step down in credit quality and size, according to strategists at credit-research firm CreditSights,” concludes Barron’s.
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