BDCs are a small industry with a total market capitalization of around $26 billion. But the industry has been growing rapidly as small companies seek sources of capital. There are now 30 BDCs, up from four a decade ago.
Under tax rules, BDCs must pay shareholders 90% of their income. These days, the income has been rich. As a result, the ETFs have been paying fat dividends. Market Vectors BDC ETF yields 7.7%, while the ETRACs ETN yields 7.2%.
Make no mistake, the funds come with significant risks. When interest rates rose in May, BDC stocks slipped. Investors worried that rising rates could hurt profits by making it more expensive to borrow. Since then, the stocks have rebounded. During the past year, the ETRACS ETN returned 21.6%, compared with 27% for the S&P 500, according to Morningstar.
The greatest risk for BDCs are defaults. The companies typically make loans to small and mid-sized companies. Such businesses often turn to the BDCs because they can't obtain cheaper financing from conventional banks. During the financial crisis, the BDC stocks declined sharply. Analysts say that the companies are on sound footing these days because they are using less leverage and loaning to companies with stronger balance sheets.
ProShares Listed Private Equity holds public shares of 28 companies. A BDC in the portfolio is
BlackRock Kelso Capital
. Market Vectors BDC Income holds shares of 26 companies, including
At the time of publication the author had no position in any of the stocks mentioned.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.