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Tailwinds for Business Development ETF

This article was originally published on ETFTrends.com.

High-yield, income-generating asset classes are often vulnerable to interest rate tightening by the Federal Reserve, but business development companies (BDCs), as measured by the VanEck Vectors BDC Income ETF (BIZD) , have recently been sturdy. BIZD is up nearly 4% since the start of the second quarter.

BDCs essentially help fund small $5 million to $100 million businesses. Ever since the financial crisis, regulators have clamped down on traditional lenders and made it harder for businesses to access public capital, which has forced smaller business to take loans from BDCs.

“Recent legislation has been serving as a tailwind for business development companies (BDCs). The passage of this year’s omnibus spending bill, which included the Small Business Credit Availability Act (SBCAA), as well as last year’s tax reform were expected to positively impact BDCs,” said VanEck in a recent note. “In fact, since the spending bill’s March 22 announcement, the MVIS US Business Development Companies Index was up 6.9%, outperforming the main U.S. equity and other high yield indices.”

More BDC Details

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. Furthermore, these companies should also do relatively well in the kind of environment ahead where many expect an increase in interest rates since most BDC loans set to float with interest rate benchmarks.

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BDCs currently average about 9.3% in dividend yield and over 80% in loan portfolios with floating rate loans, which may allow BDCs to benefit from a rising interest rate environment,” said VanEck. “As such, BDCs may serve as a complement to income allocations to help enhance yield without adding significant interest rate risk. In addition, BDCs have historically offered a competitive risk/return tradeoff when compared with high yield bonds, leveraged loans, and equities across the market capitalization spectrum.”

Floating rate notes, like the name suggests, have a floating interest rate. Specifically, the notes’ have a so-called reset period with interest rates tied to a benchmark, such as the Fed funds, LIBOR, prime rate or U.S. Treasury bill rate. Due to their short reset periods, these floating rate funds have relatively low rate risk.

“Combined with the recent tax reform and passage of the SBCAA, we believe the current case for BDCs is compelling. High yield and equity income investors may want to consider a diversified allocation of BDCs to complement their traditional income portfolios,” according to VanEck.

For more information on the fixed-income markets, visit our bond ETFs category.