VanEck Vectors BDC Income ETF: Strong, 9.2% yield, cheap valuation
The VanEck Vectors BDC Income ETF (NYSEARCA:BIZD) is a business development company, or BDC, an index ETF. BIZD’s underlying companies are focused on small and medium-sized business lending, a lucrative, high-yield but relatively risky niche. BIZD offers investors a strong growing yield of 9.2% and cheap valuation. That Fund is a buy, but relatively risky, so only suitable for more aggressive investors and retirees.
BIZD – basics
- Investment manager: VanEck
- Dividend yield: 9.20%
- Management Fee: 0.40%
- CAGR of Total Return (Initial): 5.79%
BIZD is a US BDC index ETF. BDCs are financial institutions that provide funds, usually loans but sometimes equity, to small and medium-sized US businesses. BDCs are generally fairly diversified, albeit less than the average mega-cap bank. For example, Ares Capital (ARCC), the fund’s largest holding, has the following portfolio.
As seen above, ARCC is focused on credit, with credit making up 84% of the company’s portfolio. Most of these loans, over 70%, are senior secured loans, almost all of which are adjustable rate loans. That means the company’s loan portfolio provides for higher interest rates when interest rates rise, as is currently the case. Equities make up 8% of the company’s portfolio, while preferred stocks make up the remaining 9%. Concentration is fairly low, as the company invests in dozens of industries and hundreds of issues, and no position accounts for more than 1% of the company’s portfolio. ARCC’s portfolio is relatively profitable, with a weighted average yield of 8.7%, as the company focuses on smaller, riskier issuers.
ARCC is broadly representative of the Fund’s underlying holdings. BIZD holdings are focused on senior secured/adjustable rate loans with smaller equity investments. BIZD holdings typically feature diversified portfolios with low concentration. Yields tend to be high, but credit quality is comparatively low. On the other hand, ARCC is slightly better managed than its peers, as evidenced by the company’s industry-standard returns.
BIZD itself tracks the MVIS US Business Development Companies Index, a broad market capitalization index of US BDCs. It is a simple index that invests in all applicable companies subject to a basic set of industries, revenue sources, liquidity, size and other selected criteria. BDCs are a relatively niche industry, resulting in a relatively concentrated fund with below-average diversification. BIZD invests in just 25 different holdings, with the top ten accounting for 75% of the fund’s value. These are as follows.
Diversification is somewhat poor, especially given the significant positive correlation between the fund’s underlying holdings. Concentration and lack of diversification increases risk and volatility, exposing the Fund and its investors to the possibility of significant under- and overperformance. This is in general Not This is the case with more diversified equity index funds. BIZD is a relatively risky investment, definitely riskier than average. Therefore, in my opinion, the position sizes should be kept relatively small.
BIZD’s outputs are a bit different than average and cause a lot of confusion for many investors. For regulatory reasons, BDCs and BDC funds must include their operating expenses, i.e. salaries and the like, in the calculation of the expense ratios. This serves to boost reported expense ratios, with BIZD itself boasting a massive 10.1% expense ratio. Although said expense ratio is I agree, it is not comparable to that of most funds, nor is it of particular importance for investors. BIZD also reports a management fee, which measures the actual expenses that the fund charges to unitholders and is currently 0.40%. This management fee is comparable to the expense ratio reported by most other funds and is of much greater importance to unitholders.
BIZD – investment work
BIZD’s investment thesis is fairly simple, focusing on the fund’s strong, growing yield of 9.2% and cheap valuation. Let’s take a look at each of these two points.
Strong growing 9.2% yield
BIZD’s underlying holdings are focused on loans to relatively small, risky issuers. These loans typically carry high interest rates, resulting in significant income for the Fund and significant dividends for its investors. BIZD itself has a 9.2% yield, an incredibly strong yield and significantly higher than most asset classes, including stocks and bonds.
BIZD’s yield is also likely to rise somewhat in the coming months as the Federal Reserve hikes interest rates, which should result in higher interest rates on BDC loans, ultimately leading to higher income for the fund and higher dividends for shareholders. As should be clear from the description, this is a relatively long, laborious process, so growth should be uneven and take months to materialize, however should materialize.
Some of BIZD’s underlying holdings have beautiful reported higher interest rates on their loan portfolios due to rising interest rates. As an example, ARCC’s management mentioned in its most recent earnings call that yields on its loan portfolio rose 0.60% last quarter due to rising interest rates. Higher interest rates on ARCC’s loan portfolio should ultimately increase ARCC’s earnings, which would result in higher dividends, higher revenues for BIZD, and higher dividends for BIZD and its shareholders.
BIZD’s dividends have beautiful saw some growth, with the fund increasing its quarterly dividend by more than 17% last quarter. Annualizing the most recent quarterly dividend yields 10.2%, a full percentage point higher than the fund’s current TTM dividend yield. ETF dividends tend to be volatile, so I wouldn’t put too much emphasis on a single quarterly dividend payment, but the situation seems broadly positive.
BIZD’s strong, growing yield of 9.2% is a significant benefit to the fund and its shareholders, and the fund’s core investment thesis.
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 significantly lower than most broad-based equity indices and financial industry indices. It’s an incredibly cheap valuation, even though the fund tends to trade at lower multiples than its peers.
BIZD’s cheap valuation could result in some capital gains for shareholders if valuations normalize, a benefit for them. With valuations not significantly below their historical averages, there is potential for significant Profits reduced, but some profits are still possible.
BIZD – Review
I wanted to take a quick look at my previous article on BIZD. In this article, I gave the fund a neutral rating due to valuation and yield concerns. Since then, the fund’s fundamentals have improved significantly as dividends and yields have risen, expected dividend growth has risen while valuations have fallen. Improving fundamentals have prompted me to reassess the situation, hence the rating change.
That being said, the neutral rating was (mostly) the wrong choice as most equity indices have since suffered modest losses while BIZD is flat. Didn’t expect the stock market to be bearish, hence BIZD’s outperformance.
BIZD’s strong, growing yield of 9.2% and cheap valuation make the fund a buy.