Business Development Companies ("BDCs") fall under a special designation of the Investment Company Act of 1940 ("the 40 Act"). BDCs typically lend capital or provide services to private companies and public companies with thinly traded securities, often taking positions in both the equity and debt securities of those companies. BDCs are about as close as retail investors can get to the exposure institutional investors obtain with private equity investments.
On February 12, Van Eck Global launched the Market Vectors BDC Income ETF (BIZD). According to the BIZD website, "little public information exists for private and thinly traded companies, and there is a risk that investors may not be able to make fully informed investment decisions." Although made as a risk disclosure instead of featured attribute, BIZD and its underlying BDC holdings will try to mitigate much of that uninformed risk.
To qualify as a BDC, a company must meet four criteria:
- Be organized under the laws of the U.S.
- Have its principal place of business in the U.S.
- Be registered with the S.E.C.
- Elect to be regulated as a BDC under the 40 Act
BIZD has a stated expense ratio of 7.56%, which requires additional explanation. BDCs have their own operating expenses (such as payroll) that are separate from their investments in the underlying companies. Regulation under the 40 Act also implies that BDCs are funds, which then makes BIZD a fund-of-funds.
For BIZD, the average weighted expense ratio of its BDC holdings is 7.16%. The SEC requires the disclosure of acquired fund fees and expenses ("AFFEs"). Therefore, BIZD has direct expenses of 0.40% and an AFFE of 7.16%, for a total annual expense ratio of 7.56%. See BIZD expense ratio for additional details.
The underlying index directly tracks the performance of BCDs and already accounts for their expenses. Therefore, BIZD should theoretically underperform its index by only 0.40% instead of 7.56% per year. The underlying index has a current yield of 7.9%, making BIZD's yield about 7.5% with payments expected quarterly.
BIZD has 25 holdings including Ares Capital Corp (ARCC) 15.9%, American Capital Ltd (ACAS) 15.3%, Prospect Capital Corp (PSEC) 7.3%, Apollo Investment Corp (AINV) 6.2%, and Triangle Capital Corp (TCAP) 4.9%. All holdings are financial institutions, placing BIZD in the Financials Sector category of the ETF Field Guide.
Unlike many new products that are based on new indexes without any track record, the Market Vectors US Business Development Companies Index began in June 2007. Since inception, the total return has been -0.1% per year (versus +2.3% for S&P 500), which would be about -0.5% adjusted for the 0.4% expense ratio. The price index has lost about 6.6% a year, indicating that distributions have added more than 6% to annual gains. The index had a maximum drawdown of more than 80%, so BDC investing is not for the faint of heart. Recent performance has been much better, with the total return up about 25% (versus 14% for S&P 500) over the past year.
BIZD is the first ETF in this space but not the first ETP, as UBS launched two BDC ETNs in 2011. UBS E-TRACS Wells Fargo Business Development Company ETN (BDCS) was the first to offer exposure to BDCs in April 2011, and UBS E-TRACS 2x Leveraged Long Wells Fargo Business Development Company ETN (BDCL) came along in May 2011 with a yield leveraged up to 14.6%.
Disclosure: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.