If you think the only way to wrangle massive returns from small businesses involves writing a big personal check out to fund an unsure thing — well, fortunately, you’re wrong. Business development companies offer diversified, almost hedge-fund-esque exposure to up-and-coming ventures, not to mention generous dividends that can creep into the double digits.
How do BDCs work?
Business development companies are a creation of the U.S. government, brought to life in 1980 by Congress to help spark business and job growth across America. These entities help provide financing to small- and mid-sized businesses that might have difficulty securing funding through more traditional means (i.e., big banks).
Like real estate investment trusts, which were created roughly two decades earlier to give investors access to broad real estate portfolios, BDCs are exempt from corporate income taxes. In exchange for this favorable treatment, however, BDCs — like REITs — must pay out at least 90 percent of their taxable income back to shareholders in the form of sweet, supple dividends.
[See: The 10 Best REIT ETFs on the Market.]
You don’t get such high yields without any risks. Business development companies were clobbered between 2014 and 2016 because of heavy exposure to businesses in the energy space, which caused a string of defaults among the smaller companies that BDCs service. These companies also have the ability to use leverage to juice returns, but naturally, leverage risk then comes into play.
Rising interest rates can be problematic, too, but they can also be beneficial to BDCs that borrow at fixed income rates, as their returns can improve while their interest rate payments remain level.
If you’re new to the world of BDCs, here are a few picks where you can start your research.
Main Street Capital Corp. (ticker: MAIN). Main Street Capital is a fairly large player in BDCs, at $2.2 billion in market capitalization, that invests in a wide array of industries via floating-rate first lien and senior secured debt securities. Their criteria for portfolio companies include revenues between $10 million and $150 million, EBITDA of $3 million and $20 million, and stable, positive cash flow, among others. This leads to a diverse basket of holdings, from for-profit educator Ameritech College to Guerdon Modular Buildings to technological pricing solutions firm Zilliant.
MAIN is the best of the BDC arena right now, boasting 64 percent returns in price alone over the past year, versus nearly flat performance for the premier ETF tracking the industry.
That run has sprouted a few thorns for new buyers, as Main Street Capital’s rapidly rising stock price has knocked the yield down to less than 6 percent (still nice, but one of the lowest among BDCs). And at a price-to-net asset value above 1.7, MAIN is one of the priciest business development companies on the market.
But you’re paying for quality, and that’s what you’re getting with Main Street Capital, which has been steadily growing the top and bottom lines for years. MAIN has a dividend yield of 5.8 percent.
Apollo Investment Corp. (AINV). Apollo Investment is one of the many offshoots of Apollo Global Management LLC ( APO), this one focused on business development. AINV makes the lion’s share of its investments via secured debt (75 percent), with the rest a mix of unsecured debt, preferred and common equity, warrants and other investments.
It’s also a fixer-upper. Apollo Investment is about a year removed from a dividend cut, capping a couple of years’ worth of book value declines and poor portfolio performance. However, the company has been paying off debt, shedding its energy assets and restructuring its business strategy to “reposition a portion of our portfolio in a steady and coordinated manner into traditional corporate loans directly sourced from the Apollo platform.”
[See: 20 Awesome Dividend Stocks for Guaranteed Income.]
Is AINV a sure thing? Hardly. But the comeback potential combined with a nearly 10 percent yield are an attractive aggressive investment. AINV has a dividend yield of 9.4 percent.
TriplePoint Venture Growth BDC Corp. (TPVG). Unlike many business development companies that invest with an eye on diversification, TriplePoint is geared toward tech, tech, tech.
That said, TPVG does at least offer a wide array of industry exposure within the technology space. Business applications software companies and e-commerce make up the biggest chunks of the pie at just 15 percent each, with the fund also boasting significant assets in conferencing equipment/services, security services, wireless communications equipment, network systems management software and financial institutions and services companies.
Better still, despite the tech focus, TriplePoint doesn’t stretch while eschewing quality; its investments must be profitable, and must achieve positive cash flow.
TPVG is a young BDC, and not a particularly aggressive one on the dividend growth front, only improving its payout once since it went public in 2014. But the high yield and placement in one of the market’s fastest-growing sectors are reason enough to be optimistic about this one. TPVG has a dividend yield of 10.8 percent.
BDC funds. If you’re not quite sure about how to gauge the BDC space, you’re not alone — it’s a complex industry that involves trying to analyze an entire portfolio with very little information at your fingertips. If that’s the case, you might be better off with an exchange-traded fund.
The choices there, however, are few and far between.
The two main funds in the space are the ETRACS 2x Leveraged Long Wells Fargo Business Development Company Index ETN ( BDCL) and the VanEck Vectors BDC Income ETF ( BIZD), both of which provide similar exposure to the BDC space, but in different ways.
BIZD is an exchange-traded fund that actually invests in the BDCs themselves. BDCS is an exchange-traded note, which is actually a debt instrument that produces returns based on an index’s performance, but doesn’t actually hold any securities. BIZD yields slightly more (8.4 percent to 8.1 percent) and charges significantly less (0.41 percent in direct expense versus 0.85 percent). But as an ETN, BDCS more closely tracks its index, and it has provided better total returns since BIZD came to market in February 2013.
[See: 7 Ways to Trade Volatility With ETFs and ETNs.]
Or, if you really want to supercharge your returns, you could consider BDCL, which provides double the returns and dividends (16 percent!) of the same index that BDCS tracks … but also the risk for double the capital losses. But fair warning: Leveraged funds can pile up losses in a hurry if things go south, so BDCL is only meant for agile, experienced traders.
More from U.S. News
7 Myths About Dividend-Paying Stocks
7 Horrendous Dividend Stocks to Actively Avoid
BDC Investing: What Is a Business Development Company? originally appeared on usnews.com
