BDCL: Yield King Of Leveraged ETFs - Leveraged ETFs
23 November 2011 - 11:16AM
Zacks
As bond rates continue to plunge, investors are left scrambling
for other ways to generate current income in a portfolio. Equity
ETFs, and especially those in less mainstream sectors such as REITs
and private equity, have become a favorite of many in this
environment thanks in large part to nearly double digit yields. Yet
as many of these sectors have become more popular, yields have
fallen back to earth, causing many investors to look even further
off the beaten path for income opportunities. For those who
are on this search, there may be a corner that you could have
overlooked; firms known as ‘Business Development Companies’ or
BDCs.
What is a BDC?
BDCs are a relatively new class of corporation that was created
by Congress in order to encourage capital flows to private
businesses from publicly traded private equity firms. These firms
generally offer companies long-term debt or equity capital to small
or middle-market private companies and have even been called ‘the
general public’s private equity funds’. Being recognized as this
type of firm has certain tax advantages that can be very beneficial
to those willing to achieve the listing. Most importantly is the
ability to avoid most corporate level taxation, making these firms
pass-through entities. In order to achieve this, firms must
distribute at least 90% of their ‘investment company taxable
income’ to investors and 98% of this figure to avoid all corporate
taxes entirely. Thanks to this structure, companies in this segment
are often among the highest yielding firms in the equity world,
making them favorites of investors who can stomach the volatility
inherent in lending to small private businesses (read Three
All-Star Leveraged ETFs).
While there are a decent number of options for those seeking
individual equities, the space is relatively unpopulated in ETP
form for the time being. One pick is the ETRACS Wells Fargo
Business Development Company Index ETN (BDCS), which follows an
index of 26 companies. Top holdings include 10% weightings to Ares
Capital (ARCC), American Capital (ACAS) and Apollo Investment Corp
(AINV) although three more companies comprise at least 5% of assets
as well. The main downside to the product is its hefty fee as
expenses come in at 85 basis points a year. However, this is more
than offset by the fund’s outsized yield which comes in at nearly
7.7% a year.
Yet, for some investors, and especially those looking for
greater levels of risk, this may not be enough. For these intrepid
asset managers, UBS also offers a leveraged option of the fund,
with the ticker BDCL. This product tracks the exact same index as
its unleveraged counterpart and actually has the same tracking fee
of 85 basis points as well. Despite these similarities, however,
there is one big difference; the 2x feature of the fund doubles the
yield as well, giving BDCL a current annual leveraged yield of just
under 14.6% (note that the yield isn’t exactly double the
unleveraged fund due to an assumed financing rate of 0.258%). While
this is obviously tough to beat, investors should note that the
product is not without its downsides especially in these shaky
economic environments (see Top 3 Leveraged ETFs Year To Date).
Since many of the products in this fund are considered
financials, they have not been immune from the recent turmoil and
have seen prices slump heavily over the past quarter. In fact, BDCS
has lost about 18% since inception while the leveraged version,
BDCL, has fallen by about 34.6% in comparison. Both products have
managed to turn things around in the most recent month—with both
posting modest gains—but longer term investors are likely still at
a loss. These steep falls have also likely helped to contribute to
the impressive yields for the BDC ETNs as the slumping prices make
dividend yields go higher in comparison. Should the economy turn
around and if investors regain confidence in the space, yields
could tumble as stock prices recover. Nevertheless, BDCL looks to
remain a king in the yield space for the foreseeable future thanks
in large part to the tax structure of the equities in the
corresponding index. So for investors seeking to add to current
income, but aren’t afraid to deal with significant volatility, BDCL
could be a great choice that could also help to diversify
portfolios a little more in these uncertain times (see Top Three
Leveraged ETFs For A Bear Market).
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