Fed Could Fuel Higher BDC Profits | ETF Trends

Plenty of asset classes are feeling the pain of high inflation and Federal Reserve interest rate tightening — scenarios that are making life hard on income investors.

However, some income-generating segments are, at the very least, performing less poorly than the broader market. For example, the VanEck Vectors BDC Income ETF (NYSEArca: BIZD) is outpacing the S&P 500 by about 850 basis points on a year-to-date basis.

BIZD, which tracks the MVIS US Business Development Companies Index, is dedicated to business development companies (BDCs) — one of the few income-generating asset classes that are historically positively correlated to rising interest rates. In fact, some analysts see the Fed’s newest tightening regime as boosting profits for BDCs, including some BIZD components.

“Rising interest rates will benefit the core profitability of the 24 US business development companies (BDCs) that we rate whose debt portfolios consist mainly of floating rate assets, an incremental credit positive that will help offset a likely moderate rise in asset risk under our base case,” noted Moody’s Investors Service.

That’s an indication that BIZD also has merit as an inflation-fighting vehicle because, after all, the Fed is raising rates to cool inflation with some market observers wagering that the next rate hike could be as much as 75 basis points. Additionally, it’s worth noting how and why BIZD can help investors amid high inflation and rising rates.

“BDCs are generally senior secured lenders with loans priced on a floating rate basis. Now that reference rates are above typical floor levels, BDCs’ interest income should start to rise. Interest rate sensitivity tables for Q1 2022 point to solid double-digit interest income growth if rates rise an additional 200 basis points (bps), though spread compression could blunt some of this increase,” added Moody’s.

When it comes to income, BIZD delivers in a big way, as the exchange traded fund currently sports a 30-day SEC yield of 9.17%, according to issuer data. That’s enough to keep investors competitive with inflation. Add to that, many BDCs capitalized on active debt markets to fix interest costs.

“BDCs’ funding bases have evolved over the past several years. While strong equity levels remain a core fixture of BDCs’ funding mix, many BDCs have shifted their debt funding into fixed-rate liabilities, taking advantage of open and low-cost unsecured debt markets that have picked up over the last several years,” concluded Moody’s. “This change in funding mix has locked in more of BDCs’ debt costs just as their largely floating rate debt investments begin to reap higher interest income because of rising rates , supporting our favorable outlook for core profitability.”

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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.