The Lay Of The Land For A BDC ETF

High-yielding business development companies (BDCs) are one of the asset classes benefiting from the Federal Reserve's lower for longer interest rate policy this year. That much is confirmed by a 9.5 percent rise over the past 90 days for the VanEck Vectors BDC Income ETF BIZD.

BDC ETFs

However, some analysts see the outlook for the BDC as murky in the near term, and that outlook could become ever cloudier if speculation increases that the Fed will move forward with another interest rate hike next month. Like other high-yield asset classes and ETFs, BIZD is inversely correlated to higher interest rates.

The BDC ETF is down 12.4 percent over the past year and tumbled in the latter stages of 2015 as the Fed boosted borrowing costs for the first time in nearly a decade.

Related Link: Yes, Smart Beta ETFs Are For Real

“First-quarter BDC earnings reports showed some improvement in portfolio valuations but also underscored the broader challenges facing the sector, says Fitch Ratings. Capital constraints, low market volumes and risks of asset quality deterioration continue to point to mounting dividend pressures for some BDCs, especially those with above-average leverage and outsized exposure to energy. Fitch has a Negative Ratings Outlook and sector outlook for BDCs in 2016,” said the ratings agency in a recent note.

BIZD follows the MVIS US Business Development Companies Index (MVBIZDTG), “which tracks the overall performance of publicly traded business development companies,” according to VanEck.

Happy 3rd Birthday!

The $84.1 million BIZD, which turned three years old earlier this year, holds 26 stocks, including Ares Capital Corporation ARCC, American Capital Ltd. ACAS and Prospect Capital Corporation PSEC. Though it certainly tempts, BIZD's trailing 12-month yield of nearly 9.5 percent underscores the ETF's sensitivity to changes in U.S. interest rates.

Recent Performance

However, BDC “debt is typically senior secured and set to float with interest rate benchmarks, there is diminished rate risk. When the Fed raises rates, BDC loan interest rates pegged to the London Interbank Offered Rate, or LIBOR, will also rise,” according to ETF Trends.

“BDC share prices have improved in recent months, with the rated peer group trading at a 16.1 percent average discount to net asset value as of May 18, up from a 24.5 percent discount as of 5 February, but Fitch maintains that equity issuance is likely to be limited to this year. Only one BDC raised equity capital in 1Q16,” added Fitch. “Instead, BDCs continue to focus on repurchasing shares, which contributed to a lack of improvement in leverage ratios in 1Q16. Average leverage for the rated peer group was 0.69x, flat with the prior quarter, and several firms remained at or above the upper end of their targeted range.”