As more seek out income-generating investments, investors can take a look at alternative high-yielding strategies like business development companies and related exchange traded funds that provide exposure to further U.S. growth and a potential hedge against rising interest rates.
BDCs are a good play on the growing middle America.
“One problem we see is the lack of funding for small businesses,” James L. Copell, Chief Executive Officer of Trust & Fiduciary Management Services, Master Shares, said in a call with ETF Trends. “BDCs, though, lend to small- and middle-sized businesses.”
Almost 200,000 business comprise the U.S. middle market, or about one-third of America’s private sector GDP, reports Michael Kelly for InvestmentNews. However, due to increased banking regulations, it has become harder for banks to lend to private businesses, and that is where BDCs step in.
BDCs act as an alternative to bank loan debt, helping smaller companies grow and profiting off the investments. In an expanding economic environment, BDCs should also benefit from stronger domestic businesses. Additionally, since the debt is typically senior secured and set to float with interest rate benchmarks, there is diminished rate risk.
While investors may be concerned about defaults on the loans, risk is relatively low.
“Yes, I think there is chance of fewer defaults,” Copell added.
Additionally, with the changing market environment, more investors are turning away from traditional stocks and bonds to alternative strategies as a way to diversify their investment portfolios. For instance, according to Morningstar/Barron’s Alternative Investment Study, 73% of advisors cite low correlation as a top reason for investing in alternatives.
Many are looking into BDCs for their attractive yields as they are required to pay out at least 90% of interest income received in cash dividends.
For instance, the Market Vectors BDC Income ETF (BIZD) has a 9.1% 12-month yield. Additionally, the exchange traded note UBS E-TRACS Wells Fargo Business Development Index ETN (BDCS) has a 8.61% 12-month yield and UBS E-TRACS 2x Wells Fargo Business Development Company Index ETN (BDCL) , which takes the leveraged 200% performance, has a 20.13% 12-month yield. [BDC ETF Options for High-Yield Investors]
TFMS Master Shares offers the Master Income ETF (HIPS) , which was launched in January. Rather than focusing on traditional common dividend stocks, HIPS emphasizes pass-through securities, or those companies that due to favorable tax treatment are obligated to distribute significant percentages of profit in the form of dividends – think master limited partnerships (MLPs), real estate investment trusts (REITs), business development companies (BDCs) and royalty trusts, among other asset classes. HIPS has a 7.4% yield.
For more information on BDCs, visit our business development companies category.
Max Chen contributed to this article.
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.