BDC VanEck Vectors Income ETF: High Yield, 9.2% Yield, Cheap Valuation

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The BDC VanEck Vectors Income ETF (NYSEARCA:BIZD) is a business development company, or BDC, an index ETF. BIZD’s underlying companies focus on small and medium-sized business lending, a lucrative, high-return but relatively risky niche. BIZD offers investors a solid and growing yield of 9.2% and a cheap valuation. The The fund is a buy, but relatively risky, so it is only suitable for more aggressive investors and retirees.

BIZD – Basics

  • Investment Manager: VanEck
  • Dividend yield: 9.20%
  • Management fee: 0.40%
  • CAGR of total returns (creation): 5.79%

BIZD – Overview

BIZD is an American BDC index ETF. BDCs are financial institutions that provide funds, usually loans but sometimes equity, to small and medium-sized American businesses. BDCs are generally quite diversified, although less than the average mega-cap bank. As an example, Ares Capital (ARCC), the fund’s largest holding, has the following portfolio.

ARCC Wallet

CRAC

As can be seen above, ARCC is focused on loans, which make up 84% of the company’s portfolio. Most of these loans, over 70%, are senior secured loans, almost all of which are variable rate loans. This means that the company’s loan portfolio experiences higher rates when interest rates rise, as they currently do. Equities make up 8% of the company’s portfolio, with preferred stocks making up the remaining 9%. Concentration is quite low, with the company investing in dozens of industries, hundreds of issues, and no position representing more than 1% of the company’s portfolio. ARCC’s portfolio offers a relatively high yield, with a weighted average return of 8.7%, due to the firm’s focus on smaller, riskier issuers.

The ARCC is broadly representative of the fund’s underlying holdings. BIZD’s holdings focus on senior secured/floating rate loans, with smaller equity investments. BIZD holdings tend to have diversified portfolios, with low concentration. Yields tend to be high, but credit quality is relatively low. On the other hand, ARCC is a bit better managed than its peers, as evidenced by industry-beating returns.

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ARCC Total Return Price Data by YCharts

BIZD itself tracks the MVIS US Business Development Companies Index, a broad market capitalization index of US BDCs. It is a simple index, investing in all relevant companies subject to a basic set of industry, source of income, liquidity, size and other assorted criteria. BDCs are a relatively niche industry, which results in a relatively concentrated fund, with below-average diversification. BIZD invests in just 25 different holdings, with the top ten representing 75% of the fund’s value. These are the following.

BIZD Holdings

BIZD

Diversification is somewhat weak, especially considering the significant positive correlation between the fund’s underlying holdings. Concentration and lack of diversification increase risk and volatility, and expose the fund and its investors to the possibility of significant underperformance and outperformance. This is usually not the case for more diversified equity index funds. BIZD is a relatively risky investment, significantly riskier than average. As such, position sizes should also be kept relatively small, at least in my opinion.

BIZD’s expenses are somewhat different from the average and the source of much confusion for many investors. For regulatory reasons, BDCs and BDC funds must include their operational expenses, ie salaries and other, when calculating expense ratios. This serves to inflate reported expense ratios, with BIZD itself posting a massive expense ratio of 10.1%. Although said expense ratio is exact, it is not comparable to that of most funds, nor particularly important for investors. BIZD also reports a management fee, which measures the actual expenses charged by the fund to shareholders, and currently stands at 0.40%. These management fees are comparable to the expense ratio reported by most other funds, and much higher for shareholders.

BIZD expenditure

BIZD

BIZD – Investment Thesis

BIZD’s investment thesis is quite simple and focuses on the fund’s high and growing 9.2% yield and its cheap valuation. Let’s examine each of these two points.

Solid and growing return of 9.2%

BIZD’s underlying holdings focus on lending to relatively small and risky issuers. These loans tend to carry high interest rates, which generates significant income for the fund and significant dividends for its investors. BIZD itself yields 9.2%, an incredibly strong return and significantly higher than most asset classes, including stocks and bonds.

Chart
BIZD Dividend Yield Data by YCharts

BIZD’s yield will also likely see some growth over the next few months as the Federal Reserve raises rates, which should lead to higher interest rates on BDC loans, which will ultimately translate into through increased income for the fund and higher dividends for shareholders. As is clear from the description, this is a relatively long and difficult process, so growth is expected to be uneven and could take months to materialize, but should materialize.

Some of BIZD’s underlying holdings have already reported higher interest rates on their loan portfolios due to rising interest rates. As an example, ARCC management mentioned in its latest earnings call that yields on its loan portfolio increased by 0.60% in the last quarter, due to rising rates. Higher interest rates on ARCC’s loan portfolio should ultimately increase ARCC’s earnings, leading to higher dividends, leading to higher income for BIZD, leading to higher dividends for BIZD and its shareholders.

BIZD dividends have already has seen some growth, with the fund increasing its quarterly dividend by more than 17% in the last quarter. Annualize the last quarterly dividend and you get a yield of 10.2%, which is one percentage point higher than the fund’s current TTM dividend yield. ETF dividends tend to be volatile, so I wouldn’t place too much emphasis on a single quarterly dividend payout, but overall the picture looks positive.

BIZD’s strong and growing 9.2% yield is a significant benefit to the fund and its shareholders, and the fund’s core investment thesis.

Cheap assessment

BIZD is currently trading at a relatively cheap valuation. The fund has a PE ratio of 6.4x and a PB ratio of 1.0x, both well below those of most general equity indices, as well as financial sector indices. This is an incredibly cheap valuation, although the fund tends to trade at lower multiples than its peers.

BIZD Valuation

Fund Filings – Table by Author

BIZD’s cheap valuation could lead to capital gains for shareholders if valuations were to normalize, a benefit for the same. As valuations are not materially below their historical averages, the potential for important gains is reduced, but some gains are still possible.

BIZD – Retrospective

I wanted to take a quick look at my previous article on BIZD. In this article, I was neutral on the fund, due to concerns about valuations and yield. Since then, fund fundamentals have improved dramatically, as dividends and yields have risen, future dividend growth has increased, while valuations have fallen. The improving fundamentals made me reassess the situation, hence the change in rating.

By the way, the neutral rating was (mostly) the wrong choice, as most equity indices have suffered moderate losses since then, while BIZD is flat. I didn’t expect a bearish stock market, hence BIZD’s outperformance.

BIZD Returns

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Conclusion

BIZD’s high and growing 9.2% yield and cheap valuation make this fund a buy.

Margie D. Carlisle