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Tread Carefully With This High Yield ETF

ETF Professor

From utilities stocks to real estate investment trusts and more, lower interest rates a supporting a slew of high-yielding assets this year. That theme extends to business development companies.

BDCs focused on financing for small- and medium-sized business, usually extending loans ranging from $5 million to $100 million. Their debt is usually rated as junk or not rated all. Investors can access the asset class via exchange traded funds, such as the VanEck Vectors BDC Income ETF (NYSE: BIZD).

The $233 million BIZD holds 25 BDCs and tracks the MVIS US Business Development Companies Index.

Why It's Important

Although the debt issued by BDC is usually floating rate in nature, meaning BIZD components shouldn't be plagued too much by rising interest, the ETF is benefiting from declining interest rates as highlighted by a year-to-date gain of almost 17%.

BIZD also lives up to the high-yield promise of BDCs with a 30-day SEC yield of just over 9%. Some analysts are concerned about increasing leverage in the BDC space.

“BDC leverage has been on the rise, in the wake of the passage of the Small Business Credit Availability Act, but so far has generally been accompanied by a reduction in portfolio risk and/or improved cushion to asset coverage requirements,” Fitch Ratings said in a recent note.

Much of BIZD's price action is controlled by Ares Capital (NASDAQ: ARCC), which commands over 19% of the fund's weight. If that stock can remain sturdy, BIZD should follow suit.

What's Next

While there are areas to be concerned about, many of BIZD's holdings remain on solid ground.

"Fitch's outlook for BDC ratings is stable, as rated firms are expected to remain selective on originations over the course of 2020 while maintaining sufficient funding flexibility, solid dividend coverage, and appropriate cushion to asset coverage requirements to account for potential market volatility and credit normalization,” the ratings agency said. “Fitch has Stable Rating Outlooks on eight of the nine publicly rated BDCs.”

Some BDCs are also trading at discounts to net asset value, but the discounts aren't as steep as they were a year ago.

“At Oct. 24, 2019, rated BDCs were trading at a 1.8% average discount to net asset value (NAV), compared to a 7.9% average discount a year ago, but four rated BDCs were trading above NAV, providing them access to the equity markets for growth capital,” according to Fitch.

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