Interest rates are rising, but that doesn’t mean that government bond yields are yet compelling. It also means that bond prices are declining.
Add those factors together, and these remain challenging times for bond investors. Challenging, but not hopeless. Some of the hope comes by way of alternative yield-generating asset classes, such as business development companies (BDCs). Fortunately, there’s an exchange traded fund for that: the VanEck Vectors BDC Income ETF (NYSEArca: BIZD).
BIZD, which tracks the MVIS US Business Development Companies Index, delivers the goods when it comes to income, as highlighted by a 30-day SEC yield of 7.93%. However, that’s just one chapter in a compelling income book.
“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,” notes Coulter Regal, VanEck associate product manager. “One defining characteristic of BDCs is their high yield relative to more traditional income assets like corporate or government debt. The private credit nature of BDCs, paired with their tax efficient income pass-through structure and use of leverage, is what allows BDCs to offer these attractive yields.”
BIZD holds 25 BDCs, with Ares Capital (NASDAQ:ARCC) and FS KKR Capital (NYSE:FSK) combining for nearly 31% of the fund’s roster. BDCs currently sport yields well in excess of other high-yield asset classes, including junk bonds, real estate investment trusts (REITs), and utilities stocks, but investors should remember that yield advantage isn’t a free lunch.
“When considering an allocation to BDCs, it is important to note that their yield premium over traditional income assets does comes with certain risks that investors should factor into their decision,” adds Regal. “BDCs are credit sensitive assets, because they lend to small- and mid-sized private companies, and can experience elevated volatility in ‘risk-off’ environments.”
Still, BIZD remains a relevant consideration today because it offers significant rising rates protection, which is derived from BDCs’ loans largely being tied to floating rate notes — one of the fixed income assets that does not wither when the Federal Reserve turns hawkish.
“In fact, many BDCs actually stand to benefit from a rise in base interest rates thanks to these floating rate loans paired with the fixed low rate debt that BDCs have issued over the last year. This means that as base interest rates increase, BDCs may likely see higher net interest margins and increased annual net income,” concludes Regal.
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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.