BDCs are a public play on private credit. They raise capital from investors and lend to small and midsize businesses.
Illustration by Benedetto Cristofani
In a low interest-rate world, the promise of a 7%-plus dividend yield sounds too good to be true, and with most stocks it usually is. But there’s a corner of the market where rich dividends are attractive and arguably underpromoted. Welcome to the world of business development companies.
BDCs are a public play on private credit. Created by Congress in 1980 to spur investment in small and midsize private businesses, BDCs raise capital from investors to purchase portfolios of debt and equity in companies generally valued at less than $250 million. Like real estate investment trusts, BDCs distribute at least 90% of their income to shareholders and don’t pay corporate income taxes.
Annual dividend yields of 7% to 10% are typical. In comparison, a benchmark of high-yield bonds, the ICE BofA U.S. High Yield Index, sports an annual yield of about 5.5%, and the
index yields 1.4%. Even with bond yields set to rise as the Federal Reserve begins lifting interest rates, BDCs offer attractive yields, with the possibility of growth.
They have no shortage of targets. A flood of capital into private-equity funds has meant more leveraged buyouts to finance, just as traditional banks have shied away from riskier lending in the post-global-financial-crisis era.
Private credit assets under management topped $1.2 trillion at the end of 2021, according to data provider Preqin Global, after a decade of 13.5% annual growth. Preqin expects the total to reach $2.7 trillion by 2026.
Loans extended by BDCs tend to have floating interest rates, meaning that interest income should rise as benchmark rates go up. On the other side, BDCs tend to borrow at fixed rates, holding their costs steady.
The broad BDC…