Exchange traded funds that track business development companies can provide a robust yield boost to an income-oriented investment portfolio even in a rising rate environment.
BDCs are affected by the internal health of the U.S. economy, and interest rates usually rise with an improving economy, writes Shawn Blau for Forbes.
The BDC industry has also taken steps to shelter against rising rates. The companies have structured about 60% of their assets into floating-rate investments.
BDCs have also capitalized on the low rates, restructuring the majority of their liabilities on fixed-rate terms.
Additionally, BDCs could mirror similar income investments like energy master limited partnerships. MLPs have done well even as interest rates inched higher.
Like MLPs, BDCs were designed as a special subset of investment companies. Due to the way they are structured, BDCs act as tax pass-through entities to avoid double-taxation on dividends.
BDCs lend capital or provide services to privately-held companies or thinly-traded U.S. public companies. Since BDCs have exposure to smaller companies, the companies will be susceptible to potential risks involving bankruptcies or defaults.
ETF investors interested in gaining exposure to BDCs have a few options.
The E-TRACS Wells Fargo Business Development Index ETN (BDCS) has a 0.85% expense ratio and a 7.33% annualized yield. BDCS tracks U.S.-listed BDCs. Unlike ETFs, an underwriting bank backs the exchange traded note, and if the bank goes under, investors could lose their principle.
The relatively new Market Vectors BDC Income ETF (BIZD) has a 0.40% expense ratio and a 7.35% 30-day SEC yield. BIZD also tracks U.S.-listed BDCs. The fund includes a heavier allocation toward micro-cap stocks at 40% and about 30% in small- and mid-caps. Top holdings include Ares Capital Corp 16.5%, American Capital 13.7% and Prospect Capital 8.4%.
Investors can also track globally listed BDCs with the relatively new ProShares Global listed Private Equity ETF (PEX), which has a 0.60% expense ratio and a 5.06% 30-day SEC yield. Nevertheless, North American BDCs still make up a hefty allocation at 80% and Europe accounts for the rest of the ETF. The fund leans toward mid-caps at 60%, followed by small-caps 24.9% and micro-caps 15.2%.
The PowerShares Global listed Private Equity Portfolio (PSP) is more diversified with greater overseas allocations. The U.S. is 45.6%, the U.K. 17.2%, France 7.6%, Sweden 5.2% and Canada 4.6%. The ETF also has a heavy weighting toward mid-caps at 64%, followed by small-caps 13% and micro-caps 14%. PSP has a 6.3% 12-month yield and a 0.70% expense ratio.
Max Chen contributed to this article.