ARCC - BIZD: Another Solid Year Is Ahead

Summary

• As the stock market bear trend is likely to extend into 2023 due to recessionary headwinds, it is prudent to hold a stake in high-yielding ETFs such as VanEck Vectors BDC Income.
• Despite slowing business conditions, BIZD's dividend growth is safe, and the risk of unrealized losses is limited.
• In 2023, BDCs' share prices will likely benefit from low valuations, healthy dividend growth, and strong financial growth prospects.

With a floating nature investment portfolio and robust demand for alternative financing, the VanEck Vectors BDC Income ETF ( BIZD ) is well positioned to outperform the broader market index in 2023. BIZD's dividend is likely to increase in 2023 due to strong industry fundamentals combined with a positive outlook of its portfolio holdings. Moreover, if the broader index extends the bear trend, high dividends, cheap valuations, and earnings growth of its portfolio holdings are likely to reduce the share price volatility, and these properties will also support the upward momentum if the broader market stabilizes.

Recession Unlikely to Hit BDCs' Performance

As the likelihood of a recession hitting the US economy in 2023 jumped to 70% according to the economists' poll conducted by Bloomberg , investors need to be cautious in their stock selection. This is because business activity slows down during a recession, which is terrible for most of the S&P 500 companies. However, it appears that the economic slowdown is unlikely to derail the growth trends of business development companies because BDCs are benefiting from higher interest rates due to their floating nature of investment portfolios. In addition, traditional lenders' restrictions on middle-market private companies and a decline in venture investments support higher alternative financing demand from lenders such as BDCs.

In addition, their strategy of providing first and second-lien loans to quality companies has significantly reduced the default risk of portfolio companies. As shown in the chart above, low net realized losses and non-accruals in the third quarter reflect their portfolio strength even in a widening spread environment. Furthermore, their floating nature portfolio and high-interest rate environment have helped push their weighted average portfolio yields in a double-digit percentage. According to Fitch data , over 90% of BDCs' investments are floating rates, while half of their liabilities are fixed rates.

Is BIZD the Right Choice to Capitalize on Potential Returns?

Due to the downbeat stock market outlook and economic headwinds, it might be prudent to invest in assets with lower volatility and higher dividends. I believe BDCs can protect investors from bearish trends due to their double-digit dividend yields, low valuations, and robust earnings growth quality. A BDC-focused ETF such as BIZD can further reduce the downside risk when compared to single-stock investments. There are 26 high-quality business development companies in BIZD's portfolio. With an expense ratio of 0.43, the ETF offers a dividend yield above 10%. Its total returns exceeded the broader market index returns in 2022, while the underlying fundamentals of its top holdings indicate a higher dividend and solid share price performance in the future.

For instance, Ares Capital ( ARCC ), which accounts for 20% of its entire portfolio weight, received strong buy ratings from the Seeking Alpha quant system. In the September quarter, the company generated core sequential earnings growth of 9%. In addition, its Chief Executive Officer anticipates additional growth in the following quarters due to high-interest rates and growing portfolio investments. The company's confidence in future fundamentals is also evident from a dividend increase of 12% for the December quarter, which represents its third increase in 2022.

FSK FS KKR Capital Corp ( FSK ), which accounts for 13% of its portfolio, also experienced high single-digit sequential and high double-digit year-over-year growth in net investment income in the latest quarter. Due to a robust recent financial performance and solid outlook, it recently announced a $0.61 regular quarterly dividend and a $0.07 supplementary dividend per share for the December quarter. In 2023, the dividend growth prospects are high as the company's earnings are expected to exceed $3 per share due to expectations of more interest rate increases.

Owl Rock Capital Corporation ( ORCC ), its third largest holding, also offers a double-digit dividend yield. Like its peers, Owl Rock has also raised its quarterly dividend for the fourth quarter by 4% to $0.33 per share and announced a supplemental dividend of $0.03. In addition, the $150 million worth of the share buybacks program highlights Owl Rock's strong cash position and confidence in its future. Owl Rock is expected to generate earnings per share of $1.40 in 2022 and $1.66 in the following year, which bodes well for more dividend increases in 2023. Additionally, its portfolio holdings such as Main Street Capital ( MAIN ), Golub Capital BDC ( GBDC ), Sixth Street Specialty Lending, Inc. ( TSLX ), and many others have also raised their dividends and announced supplementary dividends. In general, BIZD's double-digit dividend yield is safe because its portfolio holdings are well-positioned to raise dividends due to solid earnings quality and prospects for more interest rate hikes in 2023.

BIZD Shares Likely to Outperform in 2023

The stock market is expected to perform poorly in 2023 with 17 Wall Street strategists expecting S&P 500 to hover around 4,000 by the end of 2023. In contrast, BIZD shares are likely to perform well in both bull and bear markets. If the stock market extends the bear trend, the earnings quality of BIZD's portfolio holdings combined with dividend growth prospects would reduce its share price volatility, while these characteristics could also support upside momentum if the stock market creates an uptrend. Cheap valuations are also likely to support the ETF price. With a recent price decline and robust earnings growth, its portfolio holdings are now valued significantly lower than historic levels. As an example, its top 10 holdings, which represent 75% of the portfolio, received an A or an A-plus grade on valuation from the Seeking Alpha quant system.

In Conclusion

It's a great time to buy BIZD because the BDC-focused ETF is trading at discount and it has the potential to protect investors from short-term headwinds. Its double-digit dividend yield is completely safe while shares are likely to receive support from low valuations, robust earnings quality, and solid industry outlook. The risk factor is also low due to BDCs' floating portfolios and secured loans to quality companies.

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