Credit risk is par for the course with many high-yield asset classes and business development companies (BDCs) are no exception. Fortunately, the credit outlook for BDCs is attractive.
That’s good news for investors considering the VanEck BDC Income ETF (NYSEArca: BIZD). The first exchange traded fund to focus on BDCs sports an eye-catching yield of 13.53%. Still, there’s steak to the BIZD sizzle as highlighted by a year-to-date gain of 9.33%. Supporting the near- to medium case for BIZD is the point that BDCs are sporting the earnings power necessary to deal with potential headwinds.
“Net investment income (NII) upside is expected to be more limited from here, with rate stabilization and a potential recession, which will be headwinds to credit performance. Still, earnings growth in recent quarters provides a ‘cushion’ for an expected up-tick in credit losses,” according to Fitch Ratings.
Other BIZD Benefits
BIZD has something else in common with other high-yield asset classes: Some sensitivity to rising interest rates. However, the ETF’s vulnerability to rising rates is muted because many of the loans held by BDCs are in floating rate note (FRN) form.
That advantage was on display last year as BIZD performed significantly less poorly than both the Bloomberg Aggregate US Bond Index as well as the largest high-yield corporate bond ETF. Yes, that advantage carried over to 2023 as BIZD is again outperforming that index and the junk bond ETF.
Overall, the current credit scenario for BDCs, including BIZD member firms, is sound, according to Fitch. The ratings agency believes it’s possible a recession will arrive in the fourth quarter or in early 2024, but economic contraction isn’t likely to affect BIZD holdings in linear fashion. Put simply, some BDCs will be pinched more than others if the U.S. economy slumps.
The specter of a recession brings up another issue relevant to investors evaluating BIZD: The ability of BDCs to maintain dividends if the economy stumbles. After all, it is those meaty payouts that lure market participants to BDCs. There’s good news on that front.
“Strong dividend coverage given excess earnings from higher rates have led several issuers to raise base dividends. Eleven of 20 rated issuers announced dividend increases as part of 2Q23 earnings results,” concluded Fitch. “A growing number of BDCs have also shifted their dividend policies to include supplemental dividends based on excess earnings each quarter. This policy should provide more stability to base dividends through cycles.”
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