The VanEck BDC Income ETF: Fears Are Overblown, This Fund Is A Buy

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Business development corporations have consistently outperformed the S&P 500 in recent years, offering strong returns and income.The VanEck BDC Income ETF is one of the best-performing ETFs in this ...

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The outlook for BDCs remains solid.gopixa Finding investments with inflation-adjusted income hasn't been easy since prices began to rise significantly in early 2021. While there were many good funds and individual companies that offered individuals solid income and total returns for much of the last decade, the investing environment has become much more challenging over the last several years. A newer form of investment that has consistently outperformed the S&P 500 (SPY) over the last several years has been finance companies investing in newly formed corporations that are often referred to as business development corporations, or BDCs. The new and tougher regulation of the larger banks since 2008 has created a large market for BDCs to lend money to medium and small businesses, and BDCs have found strong demand for their financial products. One of the best-performing exchange-traded funds that invest in BDCs is the VanEck BDC Income ETF (NYSEARCA:BIZD). This exchange-traded fund has offered investors a total return of 32.17% over the last 3 years. The S&P 500 has offered investors total returns of 24.11% during this same time period. Data by YCharts Today I am initiating my coverage of BIZD with a rating of buy. The economy remains stable despite consensus forecasts for slower growth this year, increasing rates have led to higher payouts on the debt BDC are lending to medium and smaller companies, and this VanEck fund is well diversified with a good focus on many of the better-managed BDCs. Interest rates should also remain elevated for some time because of multiple factors, but the economic data continues to show the US is likely to avoid a recession. BIZD has a current yield of 11.04% and the fund has $1.03 billion in assets under management. The fund has 27 holdings, but the top 10 equity positions make up 73.83% of the ETF. The three biggest positions of this fund, which make up a combined 43% of the ETF's assets, are Ares Capital Corp. (ARCC), Blue Owl Capital Corp. Ordinary Shares (OBDC), and FS KKR Capital Corp. (FSK). A list of BIZD's top holdings (Seeking Alpha) BDCs perform best in an economic environment where rates are slightly elevated, but the economy is stable, which is what we are seeing now. If rates rise too much, the risk of default becomes alarmingly high, but if rates are too low, the lending markets offer minimal income and total returns. BIZD has predictably outperformed since early 2021 as rates have begun to rise, with the fund's 3-year dividend growth rate during this period being 7.34%, while the ETF's 10-year dividend growth rate is a disappointing 3.4%. Despite overblown fears of a prolonged recession or increased defaults with rates riser, BDCs continue to perform well. Blue Owl recently reported record net investment income, or NII, in the fourth quarter. This was the fourth consecutive quarter the company reported record NII. Ares Capital grew the company's portfolio value to $22.87 billion in the fourth quarter, from $21.9 billion the year before. The company also reported that income rose from $174 million a year ago, to $413 million in 2023. While FS KKR Capital Corp has reported a modest rise in nonaccruals to 8.9% in the last quarter, the company's net investment income still covered the regular and special dividend payout. FSK is also well diversified, and the lender relies heavily on floating rate loans, so interest rate movements are key for this company, as they are for much of the industry. The BDC is invested in 11 different sectors. A list of KKR's investments by sector (KKR investor page) The outlook for BDCs remains solid as well. Even ratings agencies that are negative on this industry, such as Fitch, a company that has repeatedly been too negative on this sector since 2016, have stated that net investment income of BDCs should remain strong in 2024. Fitch noted that many companies have been able to raise significant unsecured capital, showing the lending markets remain strong for middle and smaller corporations. Other analysts, such as Putnam Investments, have noted that the continued tightening of regulations on big banks and higher rates should lead BDCs to likely outperform in 2024 as well. The Fed remains, as Powell recently stated, unlikely to lower rates significantly in the near term for multiple reasons. Even though the rate of inflation has generally moderated over much of the last year, prices have stayed high in most parts of the economy, and the factors creating the current inflationary environment aren't likely to change anytime soon. Rising wages resulting from the labor shortage should continue. Economists are forecasting the labor shortage to persist for several years, with the US population now aging, and there are also more people able to make a living using nontraditional means such as online business as well. Government spending isn't likely to fall significantly in the near term, either. Both Republicans and Democrats have supported deficit spending for nearly two decades now. Still, even though price levels and rates should remain elevated for some time, the economic consensus remains that the US economy will grow slowly but still be able to avoid a recession. Even though real wages are not rising, unemployment remains at very low levels and consumer spending remains healthy. A chart of US consumer spending levels (The Federal Reserve) Household debt levels and delinquency rates on loans remain at solid levels as well, despite a slight increase in defaults. A chart of US household debt and Loan delinquencies (Federal Reserve) While the economic consensus in the US remains one for slow growth, with the Congressional Budget Office forecasting growth of 1.5% in the US this year, all indicators point to the American economy avoiding a recession this year. This is why BDCs should still offer solid income and continue to outperform in 2024. Valuations generally remain reasonable across this industry. Ares Capital, Blue Owl Capital, and FS KKR Capital, all trade below these companies' five-year average valuation levels by around 5-10% when comparing the share price to the NAV of these lenders. FS KKR Capital is also the only major holding of this VanEck fund that has seen a noticeable rise in defaults, and that increase was still just 2 percentage points. All investment theses have risks, and if rates were to fall significantly because of inflation falling, or if the US economy were to enter a recession, most BDCs would underperform. The risk of defaults in a deteriorating economy would rise significantly, and because most BDCs rely heavily on floating rate loans, the business models of these companies are more vulnerable to rates rising and falling than most industries. Still, these situations look unlikely.  Business Development Corporations saw one of the industry's best years in 2023, and while these companies are likely to see slightly slower growth in NII in 2024, the overall outlook for these lenders remains solid. The Fed is not likely to significantly lower rates this year, and multiple indicators show the US economy remains stable despite the outlook for slower growth this year. Also, while even small changes in interest rates can impact coverage of dividend payouts for companies with many floating loans, BDCs such as KKR have still been able to comfortably pay dividends even after seeing some modest increases in delinquencies. Patient investors who are likely for solid income should continue to find Business Development Corporations appealing in 2024.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2428343243"}