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 for a year, you can earn $400 in passive income. Finding stocks that average a 5% yield can increase your annual earnings to $500.
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 (ETFs) now, especially if they’re getting closer to retirement.
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Business development companies give investors the opportunity to generate high cash flow from their capital. But BDCs 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 for income.
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.
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, “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.
While the Federal Reserve’s potential rate reductions stand to help BDC investors, it’s important to keep in mind that dividend distributions from BDCs are treated as ordinary income. That means you’ll get taxed at a higher rate compared to qualified dividend distributions from publicly traded corporations.
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 Adobe Inc. (ADBE) 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/ETF | Yield* |
| Blue Owl Capital Inc. (OWL) | 3.4% |
| Main Street Capital Corp. (MAIN) | 6.1% |
| Ares Capital Corp. (ARCC) | 9.2% |
| FS KKR Capital Corp. (FSK) | 14.2% |
| VanEck BDC Income ETF (BIZD) | 10.9% |
| Invesco Global Listed Private Equity ETF (PSP) | 2.3% |
| Global X Alternative Income ETF (ALTY) | 7.5% |
*Trailing-12-month yield for BDC stocks; 30-day SEC yield for ETFs.
Blue Owl Capital Inc. (OWL)
Blue Owl Capital, previously known as Owl Rock Capital Corp., invests in mid-market U.S. companies. The company prioritizes real estate, credit and strategic capital. It has $192 billion in total assets under management, which is up by 28% year over year.
The firm has a BBB+ Fitch rating and $2 billion in liquidity. Shares are up by 22.1% year to date as of Aug. 19 and pay a forward dividend yield of 4% (3.4% trailing).
Main Street Capital Corp. (MAIN)
Main Street Capital offers monthly dividend payouts that come to a trailing-12-month yield of 6.1%. Shares are up by 20.8% year to date. The BDC stock has $7.6 billion in capital under management with 194 companies in its portfolio. 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. The average investment size is $20.2 million.
Ares Capital Corp. (ARCC)
Ares Capital prioritizes middle-market companies and has delivered an 8.9% year-to-date return for investors as of Aug. 19. The BDC comes with a 9.2% yield.
The firm reported $26.1 billion in assets under management in the second quarter of 2024, which ended on June 30. Ares Capital also has $601 million in cash and cash equivalents. It currently has investments in 525 companies, with the top 15 investments making up 27% of the total portfolio.
FS KKR Capital Corp. (FSK)
FS KKR Capital Corp. has $14.1 billion in assets under management spread across 208 portfolio companies. More than half are in the following industries: software and services, capital goods, commercial and professional services, and health care equipment and services. About 20% of the portfolio is concentrated in the top 10 investments.
Shares are up by only 6.5% year to date, but they come with a 14.2% dividend yield. The firm provides customized credit solutions to private middle-market U.S. companies.
VanEck BDC Income ETF (BIZD)
VanEck BDC Income ETF is up 6.4% year to date. It gives investors exposure to various business development companies, including high-income BDCs. The fund’s 30-day SEC yield is 10.4%, but keep in mind that its expense ratio is enormous, at 11.17%. This ETF specializes in private credit and lending to middle-market companies. It has $1.1 billion in total net assets.
The fund’s top three holdings are Ares, FS KKR and Blue Owl. Those three stocks make up about 40% 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 include 40 to 75 private equity companies, BDCs and master limited partnerships, or MLPs. PSP has gained about 10% year to date, 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 SEC yield may be lower than those of the other investments on this list, but its net expense ratio is lower, too, at 1.06%, and its trailing-12-month yield as of July 31 is 8.3%.
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 Emerging Markets Bond ETF (EMBD), Global X Nasdaq-100 Covered Call ETF (QYLD) and Global X US Preferred ETF (PFFD). These three investments represent 60.5% of the fund’s assets.
ALTY has a relatively low expense ratio of 0.5%, and it’s up by 7.7% so far in 2024. 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 08/20/24: This story was previously published at an earlier date and has been updated with new information.
