Interest rates are likely to soon rise, but real yields will still be low, prompting many investors to embrace high-income exchange traded funds.
Income-hungry investors might want to consider some of that category’s more unique offerings, including the VanEck Vectors BDC Income ETF (NYSEArca: BIZD). BIZD, the dominant name among ETFs focusing on business development companies (BDCs), tracks the MVIS US Business Development Companies Index, and sports a tidy 30-day SEC yield of 7.89%.
“Annual dividend yields of 7% to 10% are typical. In comparison, a benchmark of high-yield bonds, the ICE BofA U.S. High Yield Index, sports an annual yield of about 5.5%, and the S&P 500 index yields 1.4%. Even with bond yields set to rise as the Federal Reserve begins lifting interest rates, BDCs offer attractive yields, with the possibility of growth,” reports Nicolas Jasinski for Barron’s.
BDCs derive their income from the difference between the rates at which they lend money to portfolio companies and their own interest and debt obligations. For example, if one of BIZD’s 25 member firms lends money to a mid-sized business at 10%, but the BDC’s cost of that capital is just 3%, that’s a scenario likely to please investors.
Moreover, there’s some rising rates protection offered by the asset class and BIZD itself. While investors often view corporate loans through the lens of fixed interest rates, the reality is that more than eight in 10 loans made by BDCs have floating rates, which provide significant advantages against the backdrop of Federal Reserve tightening.
“Loans extended by BDCs tend to have floating interest rates, meaning that interest income should rise as benchmark rates go up. On the other side, BDCs tend to borrow at fixed rates, holding their costs steady,” according to Barron’s.
Adding to the allure of BIZD is the fact that the current climate is a target-rich environment for BDCs because so many companies need access to capital. BDCs, including BIZD member firms, fill voids ignored by banks and their often burdensome credit standards.
“They have no shortage of targets. A flood of capital into private-equity funds has meant more leveraged buyouts to finance, just as traditional banks have shied away from riskier lending in the post-global-financial-crisis era,” concludes Barron’s.
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