With a 30-day SEC yield of about 14%, the VanEck Vectors BDC Income ETF (NYSEArca: BIZD) certainly standouts in today’s low-yield environment.
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.
BIZD’s big yield is undoubtedly tempting, but their investors should perform due diligence. Business development companies and related ETFs 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.
“There is a flip side, though. In stressed environments such as the current one, banks can lower borrowing limits and demand additional collateral, or cash, if assets lose value. Lenders can also be squeezed from both sides if their own portfolio companies rush to draw down credit lines, which happened in March,” reports the Wall Street Journal.
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.
“Lenders that are worried about their standing with banks are less likely to make new loans to businesses ranging from regional restaurant chains to upstart software companies, analysts said. But efforts to address the problem, such as stock sales, can lower returns for investors,” according to the Journal. “BDCs that have raised money recently have generally said they were being prudent as they faced the uncertainty generated by the coronavirus pandemic.”
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.
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