Business Development Firms Should Benefit From New Tax Legislation
Business Development Corporations (BDCs) should benefit significantly from the new federal tax law that reduces the corporate tax rate to 21 percent from 35 percent.
One way to invest in a range of BDCs is to buy shares of VanEck Vector BDC Income ETF (BIZD), an exchange-traded fund (ETF) designed to track the performance of these stocks. Improving conditions in the business development sector led Jim Woods, editor of the Invest successfully newsletter, to recommend BIZD recently.
The new federal tax law passed in December is expected to be positive for BDCs, confirmed Meredith Larson, product manager at VanEck. However, rising interest rates and yields on US government bonds hurt BDCs and markets amid inflation fears.
BDCs mainly use variable rate loans
BDCs are structured to deal with any rise in interest rates, since more than 80% of their debt portfolios are typically floating rate and most of the debt is senior guaranteed, which should offset some part of the “negative impact” of further interest rate hikes, Larson mentioned. BDCs are also limiting their exposure to “more volatile sectors,” such as energy, relative to others, she added.
As shown in the chart below, BIZD fell slightly in 2018 but started to climb again from the close at $ 15.74 per share on February 5 following a market correction. However, its share price is starting to recover and perhaps now offers investors the option of buying the fund at a discount.
Another attraction of the ETF is that it currently pays a yield of 9.27%. It also owns 27 BDCs, although 20.67% of its assets are in one position, Ares Capital Corp. (NASDAQ: ARCC). The top 10 holdings of the fund are listed below.
Woods cautioned subscribers in the March issue of Invest successfully to shift exposure to US equities out of “proxy bond” sectors, such as utilities, consumer staples, real estate investment trusts (REITs), master limited partnerships (MLP) and personal care health, while moving towards “relaunch»Sectors such as banking, industrials, small caps and value funds. I asked Woods if BDCs could also be an interest rate sensitive bond surrogate market segment that will face headwinds as yields rise.
“I think technically speaking BDCs are considered bond agents,” Woods replied. “But that doesn’t mean they aren’t good places right now. If we consider that income investors always need a return, as well as an appreciation in stock prices, then BDCs offer a good option – not as good as dividend-paying stocks, but better than REITs and MLPs. energetic. “
BIZD’s over 9% yield is quite difficult for most dividend paying stocks match. A good argument can be made for including BDCs in one’s portfolio, especially for investors who want income.
Even though the BIZD is currently trading below its 200-day moving average, the rationale for investing in the fund rests more on its upside potential due to improving conditions for BDCs, Woods said. These conditions could take the fund above the 200-day moving average as its share price rises.
Another advantage is that the fund has a modest expense ratio of just 0.41 percent, which is “very low” compared to many other specialist ETFs, Woods said. While the fund’s “net expense ratio” is listed at 9.67%, this figure reflects the expense ratios underlying BDCs in the fund, not what BIZD charges, he added.
To describe how BDCs differ from typical lenders, I turned to Christopher Testa, an equity research analyst who tracks the industry for the National Securities Corporation (NSC).
BDCs originate from the Investment Company Act of 1940, which regulates companies that are primarily engaged in investments and gives them favorable tax treatment, provided they distribute 90% of net operating income, Testa explained. . In 1980, Congress created specific business development company legislation to stimulate investment in middle market companies in the United States, he added.
BDCs have been given more leverage to fund mid-market companies, with the same restriction on distributing 90% of net operating income in order to maintain tax-advantaged status, Testa said.
“All other things being equal, the majority of the industry will benefit from the rate hike,” continued Testa. “Now you get what you pay for. There’s a reason the average return in the BDC sector is around 10%, according to NSC research, because lending to businesses 6 to 5.5 times is leverage. , compared to banks doing a twice leveraged revolver, carries a lot more risk. . “
BDCs lend to small and medium-sized businesses in the market
BDCs must devote 70% of their assets to “qualifying investments,” which are loans to small and medium-sized businesses in the market, Testa said. BDCs face limits for investing in real estate, online lending and secured loan bonds, he added.
Additionally, BDCs trade as closed-end funds (CEFs) with a limited number of shares outstanding. Therefore, individual BDCs can either trade at a premium, when the market price exceeds the total returns to net asset value (NAV), or at a discount, if a fund’s share price is below the returns. NAV totals.
CAEs currently have an average 15.45 percent discount, allowing investors to buy many funds whose share price is lower than their total NAV return.
One reason for the discount could be that investors “don’t fully trust” NAVs because management may not mark asset values with sufficient precision, Testa said. A second reason why some BDCs might trade with discounts is due to high non-accruals, underperformance, and investments in secured loan bonds, secured loan bonds, online loans, and real estate, he added.
“These factors combined are usually what creates big discounts,” Testa said. “Now if you look at BDCs that trade in premiums, they’re generally boring in the sense that they only make middle market loans. They are doing what they should be doing. They have prudent capital management. They have lower fee structures. And they have a habit of consistently marking the book as it should, and usually a stable to rising NAV per share. “
For investors who want to earn a dividend yield above 9% without having to assess why some BDCs are trading at a discount or premium, BIZD might be worth considering.
Paul Dykewicz is an accomplished and award-winning journalist who wrote for Dow Jones, the the Wall Street newspaper, Daily Investor Business, USA today, the Trade Journal, Search for Alpha, GuruFocus and other publications and websites. Paul is the editor of StockInvestor.com and DividendInvestor.com, writer for both websites and columnist. He is also the Editorial Director of Eagle Financial Publications in Washington, DC, where he publishes monthly investment newsletters, urgent trading alerts, free e-letters and other investment reports. Paul was previously the editor of a daily newspaper in Baltimore. Paul is also the author of an inspiring book, “Holy Smokes! Gold guide of the chaplain of the Notre-Dame championship», With a foreword by Lou Holtz, former national championship winner football coach.