Business development companies and related exchange traded funds have been hammered on fears of increased loan defaults in the wake of the coronavirus pandemic, but the sector has surged as aggressive stimulus measures help support the beleaguered sector and the lower-for-longer yield environment attracts income-minded investors.
The VanEck Vectors BDC Income ETF (NYSEArca: BIZD) jumped 18.5% on Wednesday after surging 12.5% in the previous session. BIZD shows a 10.1% 12-month yield.
Additionally, the ETRACS Linked to the Wells Fargo Business Development Company Index ETN Series B (NYSEArca: BDCZ) advanced 19.9% on Wednesday after increasing 10.6% the day prior. BDCZ has a 9.5% 12-month yield.
Business development companies generate attractive yields since they are required to pay out 90% of income in the form of dividends. This is a structure similar to what income investors find with real estate investment trusts, or REITs.
BDCs are comprised of companies that fund small- to mid-sized private companies, which are usually rated below investment grade or not rated at all – these companies would find it harder to acquire traditional means of loans, so they turn to outside sources of capital. Since the financial crisis, regulators have clamped down on traditional lenders, making it harder for many businesses to access public capital.
Consequently, many of these private smaller businesses turned to loans from BDCs as an alternative. BDCs act as an alternative to bank loan debt, helping smaller companies grow and profiting off the investments, which in turn would then 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.
However, this segment has been particularly hit in the recent selling over concerns that a looming coronavirus-induced recession will cause them huge losses.
“BDCs have traded down very, very hard,” Steve Zamsky, an executive at Smith Capital, a credit fund, told the Financial Times. “So much money has been raised in that space that you have to wonder whether underwriting standards have been as high as they ought to have been.”
“You have to wonder just how resilient the companies they lend to are going to be in a recession, as they generally lend to smaller companies that may have less financial flexibility,” Zamsky added. “A lot of private credit investors are probably whistling past the graveyard.”
However, the markets have turned around as Capitol Hill works on a $3 trillion stimulus package aimed at those more distressed sectors in the U.S. economy, including direct financial payments to Americans and loans to businesses
VanEck Vectors BDC Income ETF
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