With interest rates rising, income investors face some challenges, but the search for income and yield can involve some unique asset classes that can help investors reduced interest rate risk.
That include business development companies (BDCs). For investors that do not want to stock pick among BDCs, the VanEck Vectors BDC Income ETF (NYSE:BIZD) is worth considering. BIZD, which is just over four years old, tracks the MVIS US Business Development Companies Index, which includes publicly traded BDCs.
BDC's generate robust yields since they are required to pay out 90 percent of income in the form of dividends, a structure similar to what income investors find with real estate investment trusts, or REITs, according to ETF Trends.
Due to the fact that most loans made by BDCs to borrowers are floating rate loans, companies in BIZD can actually perform well as interest rates rise.
BDCs have, historically, also offered a competitive risk/return tradeoff when compared with high yield bonds, leveraged loans, and equities across the market capitalization spectrum, said VanEck in a recent note. At the same time that rising interest rates are weighing on income investors, the desire for yield persists. However, investors have options without the meaningful interest rate duration found with traditional fixed income investments, and BDCs are one of those options.
BIZD, the only pure play ETF dedicated to BDCs, makes good on delivering yield to investors as highlighted by the ETF's whopping 30-day SEC yield of 8.54 percent.
That is enticing, but BIZD is a top-heavy ETF as Ares Capital Corporation (NASDAQ:ARCC) and Prospect Capital Corporation (NASDAQ:PSEC) combine for over a third of the ETF's weight. The top 10 of BIZD's 26 holdings combine for nearly 73 percent of the ETF's weight.
While BIZD does not expose investors to significant rate risk, the trade off is some credit risk.
Investors should note, though, that the high yield of BDCs is an indication of potential credit risk, said Van Eck. While the majority of loans in the BDC space are senior secured loans (which can help increase the loan recovery potential in the event of a default), investors should have a risk tolerance for below-investment grade (i.e., high yield/BB+ or below) rated securities. In addition, publically listed BDCs are equities and, as such, may be sensitive to investor sentiment and subject to greater volatility than found with high yield bonds or leveraged loan portfolios.
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