ARCC - BIZD: High Sustainable Income From A BDC ETF

2023-11-02 07:37:56 ET

Summary

• The VanEck BDC Income ETF offers exposure to US Business Development Companies with a diversified portfolio and a high dividend yield of 11.5%.
• BDCs provide a high level of income despite what interest rates are doing.
• BIZD's top holdings consist of well-established BDCs with a track record of high dividend yields and positive total returns, making it an attractive option for income-focused investors.

Overview

The VanEck BDC Income ETF (BIZD) strives to replicate the price and yield performance of the US Business Development Companies Index. The ETF is diversified in its BDC exposure (business development companies), minimizes risk with their secured debt structure, and pays us a fat dividend yield of 11.5%. The fund's strategy entails investing at least 80% of its total assets in securities that make up its benchmark index, which consists of BDCs. BDCs are entities primarily engaged in investing in, providing capital to, or offering services to privately-held U.S. companies.

If you want to get exposure to BDC income but unsure where to start, I think BIZD is a great place to begin. The top ten holdings contain BDCs that have a strong history of NII growth (net investment growth), consistent dividend raises, supplemental dividends, and stable cash flows. I will link some examples of these quality BDCs below. Overall, I think BIZD is a great holding for someone that prioritizes reliable income over beating an index such as the S&P ( SPY ).

Benefits Of BDCs

High income produced by BDCs offers several compelling benefits investors no matter what age group or part of your journey you are in. One of the key advantages of investing in BDCs is the attractive yield opportunities they offer. BDCs are required by law to distribute at least 90% of their taxable income to shareholders in the form of dividends, creating a reliable income stream for investors. As a plus, whenever these companies make more money than anticipated, the shareholders tend to get rewarded with supplemental dividend payments. Here are examples from some of the BDCs I personally own. These BDCs also happen to be a part of BIZD's portfolio:

• Main Street Capital (MAIN) raises dividend by 2.1% and declares a supplemental dividend of $0.275/share.
• Gladstone Investment Corp (GAIN): huge supplemental dividend of $0.88/share paid in December. The regular dividend payout is $0.08/share on a monthly basis. This means that the announced supplemental is worth 11 months of pay! I recently rated GAIN as a Buy.
• Golub Capital (GBDC): raised dividend by a massive 12% and paid a supplemental in September.

Furthermore, BDCs often invest in a diverse portfolio of small and medium-sized businesses across various sectors. This diversification can help mitigate risk because it reduces the impact of poor performance in any one company or industry. It allows investors to participate in the potential growth of multiple businesses while enjoying income stability.

Lastly, BDCs are subject to rigorous regulatory oversight, providing investors with a level of transparency and investor protections that may not be available with other types of private investments. This regulation can offer peace of mind to investors concerned about the potential risks associated with private company investments.

Holdings

BIZD contains 25 different BDCs within and I really like the top five holdings. This is because the top five holdings happen to all be BDCs that I own and have continued to provide me with a high level of income throughout the last 4+ years. The top five holdings are as follows:

1. Ares Capital ( ARCC )
2. FK KKR Capital Corp ( FSK )
3. Blue Owl Capital ( OBDC )
4. Golub Capital BDC
5. Blackstone Secured Lending Fund ( BXSL )

Granted, Blue Owl and Blackstone Secured Lending are newer funds with less of an established history. As we can see though, they have all provided positive total returns since the pandemic while also each providing shareholders with a high dividend yield. As of right now, all of their yields sit close to 10%, with the exception of FS KKR Capital ( FSK ) coming in at a whopping 14% dividend yield. BIZD's top ten holdings account for a third of their portfolio.

I only mentioned the first top five holdings so the remaining half of BIZD's top ten holdings consist of the following:

6. Hercules Capital ( HTGC ) - which I previously rated as a Hold.

7. Main Street Capital

8. Sixth Street Specialty Lending ( TSLX )

9. Prospect Capital ( PSEC ) - which I recently rated as a Buy.

10. Oaktree Specialty Lending

These companies primarily hold senior secured corporate loans which come with many advantages. Senior secured loans significantly enhance the safety of BDCs. These loans hold a top priority in the repayment hierarchy, providing a safety net in case of borrower default. Moreover, they often come with collateral backing, allowing BDCs to recover their investments by taking ownership of these assets in the event of default.

Senior secured loans offer a predictable cash flow with fixed interest rates, ensuring a stable income source for BDCs. This is why I feel confident that we will continue to see dividend growth into the future. While investing in BDCs still carries inherent risk, the seniority and collateral associated with senior secured loans make them a safer choice within the realm of alternative investments.

High Income

The current dividend yield of BIZD sits at 11.5% and pays on a quarterly basis. The 5 year dividend growth rate average is quite low at 2% a year but this is totally acceptable for me considering the starting yield is already above 11%. BIZD has paid out dividends for 9 consecutive years and I do not see a reason to believe this to change any time soon.

Although the price growth has been negative over the last five years, your total return would still be positive at over 50%. Although it underperforms the S&P 500, I think this is negligible as not every investor's goal is to outperform the SPY. There are a lot of us out there that simply aim to have a growing source of income that can provide us with the cash flow to fund our daily lives. If you are looking for a growing source of sustainable income, I think that BIZD is a great option and has lots of quality BDCs within.

Using portfolio visualizer, we can see that if we reinvested the dividends over the last decade, our income would have nearly double with a $10,000 investment. Remember, the goal with investing into BIZD is to create a lasting source of income that also grows and the historical data tells us that the fund has been successful at this so far. Looking forward, I think we shall continue seeing dividend raises and steady income being provided, regardless of whether the price movement underperforms the SPY.

The Cons

Business development companies tend to be sensitive to changes in interest rates, primarily because they heavily rely on borrowing to finance their investments. When interest rates rise, BDCs face increased costs in servicing their debt, potentially squeezing their profit margins and impacting their ability to generate high yields for investors. Moreover, the market value of their fixed-income investments may decline in a rising rate environment, affecting their portfolio valuations.

On the flip side, falling interest rates can lead to portfolio valuation gains. Liquidity challenges may also arise, especially in an environment where investors seek higher yields to compensate for increased risks, making it challenging for BDCs to attract capital or refinance existing debt.

Additionally, the competition from other income-generating investments, such as bonds and dividend-paying stocks, can cause yield compression for BDCs, influencing their appeal to investors. Nevertheless, BDCs' sensitivity to interest rate changes can vary based on their individual strategies and risk management practices, and they may employ hedging techniques to mitigate these risks.

Takeaway

The VanEck BDC Income ETF presents a compelling option for investors seeking exposure to business development companies and their potential for high income. BIZD's diversified BDC exposure, emphasis on secured debt structures to minimize risk, and an impressive dividend yield of 11.5% make it an attractive choice. BDCs, being mandated by law to distribute a significant portion of their taxable income as dividends, offer a reliable income stream to investors.

Additionally, these companies often invest in diverse portfolios of small and medium-sized businesses, reducing the impact of individual company performance on overall returns. Furthermore, BIZD's top holdings include well-established BDCs with a track record of providing high dividend yields and delivering positive total returns. Despite the challenges posed by fluctuations in interest rates and competition from other income-generating investments, BDCs remain an appealing option for those seeking sustainable and growing income.

While BIZD may not outperform broad market indices like the S&P 500, it caters to a specific audience focused on building a dependable source of income. Over the years, BIZD has demonstrated its ability to deliver income growth, and historical data suggests that this trend will likely continue.

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