Income investing is a popular approach that involves buying well-researched assets for their yields. If you put $10,000 into quality stocks that average a 4% yield, you can earn $400 per year in passive income. Finding stocks that average a 5% yield can increase your annual earnings to $500 every year.
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Dividend reinvesting and dividend hikes can increase your yield in the long run and lead to more cash flow. You can buy stocks that offer low dividends and have more promising growth prospects, but some investors want higher yields from stable stocks or exchange-traded funds now, especially if they’re getting closer to retirement.
Business development companies give investors the opportunity to generate high cash flow from their capital. But BDC stocks come with inherent risks you should be aware of. This guide will explain business development companies, assess their pros and cons, and outline some of the top BDC stocks and ETFs to buy.
What Is a Business Development Company?
BDCs invest in small and midsize businesses. Some cases involve BDCs gaining equity positions in companies, but BDCs also invest in companies by lending money. These entities are similar to venture capital funds, but you don’t have to be an accredited investor to buy shares of BDCs.
When lending money, BDCs can set higher interest rates because they give loans to riskier businesses. Federal regulations prevent most banks from working with the companies BDCs work with, giving them the opportunity to collect more interest. But that also means more risk.
A business development company’s ability to generate shareholder value depends on its portfolio of small and midsize businesses. If those companies go under or fail to make loan payments, the BDC can face some turbulence.
Advantages of BDCs
The main draw for BDCs is their high dividend yields. You can, of course, generate capital gains from BDC shares as well. Jay Sammons, portfolio manager at Gratus Capital, explains how laws around these assets help investors seeking cash flow: “BDCs are required to pay out a large percentage of net income, so the earnings from the underlying loans are ultimately passed through to the investor.”
Just as with real estate investment trusts, or REITs, BDCs must pay 90% of profits out to shareholders via dividends. That extra cash flow can help you cover more of your living expenses instead of waiting for a non-BDC stock’s dividend to catch up through years of dividend hikes.
[READ: How to Invest Money to Make Money]
BDC Risks to Consider
Every stock has risks, though, and BDCs are far from an exception to that rule. BDCs need distressed businesses to gain value or keep up with loan payments to reward shareholders. Sammons encourages investors to look deeper into a BDC’s business relationships to see if those payouts are sustainable.
“A BDC is an investment fund that seeks to generate a return for investors by loaning money to privately owned companies. These borrowers vary greatly across industry, size and ownership structure, all of which will ultimately factor into the performance of your investment, so it’s important to understand the particular strategy of the BDC before investing.”
A 2023 GenTrust report called “The Fallacy of Income Investing” highlights some other concerns that are applicable to BDCs. While the report does not specifically address BDCs, it does touch on the dangers of yield chasing. Since BDCs appeal to investors seeking high yields, it’s important to take some of the report’s findings into consideration.
“An overemphasis on maximizing income generally exposes a portfolio to the risk of loss during a period of rising interest rates,” the report states. GenTrust encourages investors to focus on the total return of their assets instead of high yields.
Some BDCs can generate respectable returns while paying out high dividends. However, those dividends represent money that cannot be reinvested into the business. Even though companies like Amazon.com Inc. (ticker: AMZN) and Alphabet Inc. (GOOG, GOOGL) could comfortably offer dividends if they chose to, they avoid such payouts so they can reinvest more money into their businesses.
If you want to get exposure to this asset category, here are some of the top BDC stocks and ETFs to buy:
| BDC investment | Yield | YTD return as of July 31 |
| TriplePoint Venture Growth BDC Corp. (TPVG) | 12.9% | 29.7% |
| Goldman Sachs BDC Inc. (GSBD) | 12.6% | 11.0% |
| Blue Owl Capital Inc. (OWL) | 4.5% | 19.0% |
| Main Street Capital Corp. (MAIN) | 6.7% | 20.3% |
| VanEck BDC Income ETF (BIZD) | 10.3% | 14.9% |
| Invesco Global Listed Private Equity ETF (PSP) | 2.3% | 21.1% |
| Global X Alternative Income ETF (ALTY) | 7.5% | 7.7% |
TriplePoint Venture Growth BDC Corp. (TPVG)
TPVG works with clients that want to use debt financing to raise capital before going public. This business development company has a BBB credit rating and a stable performance record. The TriplePoint team has provided more than $9 billion in leases and loans to more than 3,000 leading venture capital-backed companies over the past 30 years.
TriplePoint pays a dividend yield close to 13%, and its shares have appreciated by 29.7% in 2023 as of July 31, with dividends reinvested.
Goldman Sachs BDC Inc. (GSBD)
Goldman Sachs BDC lends money to midsize businesses that are mostly located in the U.S. The BDC prioritizes income growth through debt securities but also strives for capital appreciation. Shares are up by 11% year to date as of July 31, and this BDC pays a 12.6% dividend yield.
At the end of March, in the wake of the regional banking crisis, its total investments sat at $3.8 billion across 133 portfolio companies. Goldman Sachs BDC has exposure to 37 industries, and 97.4% of its investment portfolio consists of senior secured debt, with 92.6% in first-lien investments.
[READ: 10 Best Growth Stocks to Buy for 2023]
Blue Owl Capital Inc. (OWL)
Blue Owl Capital, previously known as Owl Rock Capital Corp., invests in mid-market U.S. companies. Shares closed at $12.32 on July 31 but had a net asset value of $15.15 per share at the end of the first quarter of 2023. The company has investments spread across 187 portfolio companies, with an aggregate fair value of $13.2 billion.
The average investment size for each portfolio company was $70.4 million in the fiscal first quarter. Shares are up by 19% year to date and pay a dividend yield of 4.5%.
Main Street Capital Corp. (MAIN)
Main Street Capital Corp. offers monthly dividend payouts that come to an annualized yield of 6.7%. Shares are up by 20.3% year to date as of July 31. The BDC has $6.6 billion in capital under management with 195 portfolio companies. Main Street deals in lower-middle-market and private credit, and helps with debt financing, acquisitions and management buyouts.
Main Street Capital prioritizes companies with $10 million to $150 million in annual revenue and earnings before interest, taxes, depreciation and amortization, or EBITDA, ranging from $3 million to $20 million. Initial investment size falls between $5 million and $75 million, with an average of $18.7 million.
VanEck BDC Income ETF (BIZD)
VanEck BDC Income ETF has gained 14.9% year to date and gives investors exposure to various business development companies, including high-income BDCs. The fund’s 30-day SEC yield is 10.3%, but keep in mind that its expense ratio is enormous at 10.92%. This BDC specializes in private credit and lending to middle-market companies.
The fund’s top three holdings are Ares Capital Corp. (ARCC), FS KKR Capital Corp. (FSK) and Blue Owl Capital. Those three stocks make up 44.5% of the fund’s total assets.
Invesco Global Listed Private Equity ETF (PSP)
The Invesco Global Listed Private Equity ETF, which tracks the Red Rocks Global Listed Private Equity Index, holds securities that include global and American depositary receipts. These ADRs and GDRs comprise 40 to 75 private equity companies, BDCs and master limited partnerships, or MLPs. PSP has gained 21.1% in 2023 as of July 31, and it has a 30-day SEC yield of 2.3%.
PSP’s top 10 holdings make up nearly half of its total assets and include familiar names such as investment firms KKR & Co. Inc. (KKR) and Blackstone Inc. (BX), representing about 5% of the portfolio each. This ETF’s yield may be lower than some of the other investments on this list, but its net expense ratio is lower, too, at 1.34%.
Global X Alternative Income ETF (ALTY)
Global X Alternative Income ETF holds various alternative investments that offer high income instead of focusing solely on business development companies. The fund invests in five distinct income segments: master limited partnerships and infrastructure, real estate, preferred stocks, emerging market bonds and covered calls. ALTY’s top three holdings are other funds: Global X Nasdaq 100 Covered Call ETF (QYLD), Global X Emerging Markets Bond ETF (EMBD) and Global X SuperDividend REIT ETF (SRET). These three investments make up 62.3% of the fund’s total net assets.
ALTY has a relatively low expense ratio of 0.5%, and it’s up 7.7% so far in 2023. The fund makes monthly payouts and has a 30-day SEC yield of 7.5%.
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7 Best BDC Stocks and ETFs to Buy for Income originally appeared on usnews.com
Update 08/01/23: This story was previously published at an earlier date and has been updated with new information.
