How to Invest in BDCs (Best Dividend Stocks?)

so a few weeks ago i made a video about real estate investment trusts or reits and how investing in them through a roth ira could help you earn some incredible dividends i've just learned about a similar investment strategy with securities called business development companies or bdcs which offers some of the highest dividend payouts in the whole stock market and some of them even higher than reits so in this video i'm going to tell you everything you need to know about bdcs before investing in them i'll tell you what makes bdcs unique and why investing in them can be insanely profitable then we'll take a look at one of the best ways to invest in bdcs for diversification and juicy yields and last we'll look at the controversial regulations surrounding bdcs that might suggest that they are currently way undervalued so if you want to earn 10 12 or even 15 dividends do not go anywhere so let's start with the basics and talk about what a bdc is bdcs or business development companies were created in 1980 to encourage the funding of private companies private companies often hit a roadblock at a certain point in their growth unless they choose to go public in the early stages of business a private company can go to banks to get loans and fund the growth of their business but at a certain point these private businesses might need more funding than they can get from a bank which is typically somewhere around the 1 million to 5 million dollar mark in order to get the funding they need a private business can choose to go public and sell stock in their business on public stock exchanges this is a process called ipo or initial public offering but there are downsides to going public with a business going public means they have to follow the rules of the sec which means stricter reporting recording and accounting so many companies choose to remain private for that reason and if they need funding greater than a bank can provide turning to a bdc is one of the only options a bdc is a publicly traded investment company their sole purpose is to fund private businesses by providing them with loans or by providing cash in exchange for equity in the business they are also known to provide operational advice to these businesses to get them through the turbulence of growing a business bdc's earn money by collecting on their loans and by enjoying a share of the profits of the private businesses they invest in and bdc's are unique because they're one of the only ways for the average investor to invest in private businesses they are essentially a venture capital fund that you can affordably invest in through the stock market unlike actual venture capital funds that are highly exclusive and require tons of money and this kind of leads us into discussing the benefits of bdcs or the reasons you might want to consider investing in them as i just said they make investing in private businesses incredibly accessible and affordable this is much like how reits make real estate investing accessible and affordable for the average investor since bdcs are publicly traded you can buy individual bdcs or bdc etfs on any stock market exchange this also makes them much more liquid than investing directly into a business and one of the reasons you'd want to invest in private businesses in the first place is because they can have huge growth potential i found a study to support this but keep in mind it was published in late 2018 so it may not be quite as accurate during the coven pandemic the study showed that private companies were more ambitious when it came to growing into new markets sectors and geographic locations the same study showed that one-third of private companies anticipated annual growth greater than 10 and 85 percent of them anticipated growth greater than 5 basically this study showed that private companies drive economic growth much more than public companies bdcs also provide portfolio diversification because the returns may not be tied to the same economic factors that affect bonds and other publicly traded stocks with private businesses you're investing in a totally different market which i think is a pretty unique opportunity and of course one of the biggest reasons for considering bdc investments is the dividend payouts bdcs often have dividend yields in the double digits and this is because like reits they're required by law to distribute at least 90 of their income as dividends they earn further tax benefits if they distribute up to 98 of their income which means even larger dividends for investors but there are two sides to this so let's take a look at some of the downsides or risks of investing in bdcs the dividends although they are juicy are taxed as ordinary income instead of the typical capital gains tax rate this means you'll pay more taxes on bdc dividends than qualified dividends from other stocks the only way around this is to invest in bdcs through a roth ira because its tax advantages mean you can earn these high dividends completely tax-free and this is something that i covered in depth in my video on reits and roth iras so do check that out if you want to learn more about this another downside is that while the bdc stocks themselves are fairly liquid their assets and investments into businesses or not this means there's always the risk that one of your bdc's private businesses fail which would cause a pretty quick drop in stock value since these private businesses are often already struggling financially this is a really important risk to consider and similarly you're relying on the management skills of the people running the bdc you invested in this is not unlike the risk of fund managers running a mutual fund you simply have to trust and hope that they'll make the right investment decision and earn you a profit but the more diverse your bdc holdings are the better protected they'll be from these risks so now that we've covered the main details of bdcs hopefully you can see how exciting investing in these stocks can be especially if you don't mind a little risk in your portfolio so let's talk about what it might look like to invest in bdcs there are only 49 bdcs available on the market this makes things really simple because you won't have to sift through hundreds of stocks to figure out what to invest in and if you feel like adding some bdcs to your portfolio i would highly recommend the website bdcinvestor.com here you can easily view all available bdcs by price dividend yield annualized return and so on and yes at the time of this video there is a bdc with a dividend yield of 25 this website makes you create an account to view more than six pages but you can just use a fake email to get immediate access so don't let this scare you away now i'm a huge proponent of index fund investing for diversification and earning some more predictable long-term returns so instead of breaking down individual bdc stocks we're going to take a look at a particular bdc etf that caught my eye and this is one of just five bdc etfs that are available it's the van x vector's bdc income etf ticker symbol bicd it holds about 60 of the entire bdc market which is more than any other etf options and it also has the highest total assets and trading volume of other etf options it pays out a delicious dividend of a little over 12 percent at the time of making this video now the reason i wanted to look at this etf is one i have decided to invest in it instead of any other bdc related security and two there's something really unusual about the expense ratio of this fund that you may see in other funds that include bdc stocks depending on where you look at this van eck etf you might see an expense ratio of over nine percent i thought this was completely outrageous so i wanted to do some digging before i went any further with bdcs most index funds and etfs have management fees of usually less than one percent this etf is no different with a management fee of 0.41 the rest of the expense ratio comes from something called acquired fund fees and expenses or affe the affe rule was passed by the sec in 2006 in an effort to increase transparency for investors this rule affects any fund that invests in bdcs or other funds with expense ratios you might also hear these called funds of funds essentially if a fund or etf has something in its portfolio with an expense ratio it has to publicly report these costs so in the case of the van x ddc etf it's reporting that it incurs costs of about nine percent to acquire and hold its portfolio of 27 different bdc stocks but this is actually inaccurate and as you're about to see the nine percent cost doesn't affect investors like you and i as much as you might think and as it turns out the affe rule disproportionately affects all bdc stocks and has greatly hurt their performance in recent years as a result just a heads up this might get a little confusing so please try and bear with me bdcs are unique because there are simultaneously businesses and investment funds legally they're registered as closed in funds with the irs but they also operate as a business so they will understandably have business operating expenses when they report their earnings as any business does they simply report these operating expenses as they would with any other expense or profit and since they are investing in private businesses and not other vdcs they are not subject to the affe rule so there's nothing out of the ordinary here yet to give you an example main street capital corporation ticker symbol m-a-i-n is a popular bdc stock this past quarter they reported an operating expense of 1.4 percent which turns out to be one of the lowest expense ratios in the bdc industry they reported this as a standard business expense this means that this cost doesn't come out of the investor's pocket at least not directly this 1.4 percent is something that the markets and traders will consider in addition to many other factors as the value of the stock fluctuates but things change when a fund acquires this or any other bdc as a portion of their holdings for example the van eck bdc etf holds main street capital at a weight of about five percent vanakk charges only a point four percent management fee but they must also now disclose the fund acquisition costs of main street capital and all similar holdings due to the affe rule so now the van x etf must report an expense ratio of the point four percent they charge and the additional one point four percent that main street capital corporation incurs through business operations when you add up all of the operating expenses of van x holdings you get the reported 9.6 expense ratio but here's what really matters that nine percent isn't at the cost of investors these are costs that are already baked into the prices of individual bdcs based on their business operations so they might indirectly affect the price of the stocks but it is not a direct cost of holding the vanneck etf or the underlying vdcs hopefully that all makes sense but if not here's the bottom line funds that hold bdcs have to report high expense ratios even though they are not a direct cost to the investor so when you're researching these funds the management fee is what matters the acquired fund fees and expenses are not a direct cost so don't let that discourage you from investing in addition to knowing this information for any immediate investments this is also a really fascinating dynamic for the world of bdc's bdcs are rightfully upset by the affe rule because funds are legally required to report these expenses even though they have no direct impact on the fund's value or operation costs these expenses are effectively counted twice once in the financial reports of the individual bdc and again in the so-called costs of the funds they're included in it's for this reason that many different index funds decided to completely exclude bdcs from their portfolios and without the support of funds bdcs get much less attention and support from both retail and institutional investors but there has been a lot of pressure on the sec to revise this affe rule so that funds can more accurately report their expense ratios and attract investors and if this happens i think many funds will add bdcs back into their portfolios which could mean a huge influx of capital into the bdc market so to wrap this all up i'm very excited to be including the vanek bdc etf in my roth ira portfolio where i will be getting 100 of that sweet 12 dividend yield i'm investing to further diversify my portfolio with investments into private businesses which would otherwise be an investment class out of my reach and i'm doing all of this in confidence knowing that the vanek etf is diversified into over half of the bdc market and that the only costs i need to worry about are the reasonable point four percent management fees as usual i gotta say this is not investment advice do not do anything without doing your own research and consulting a qualified financial advisor if necessary i'll leave some links in the description of this video to some of the best bdc resources i found so do check those out if you're interested in learning more about this topic also leave a link to m1 finance which is the platform i am personally using to invest in bdcs and lots of other fun stuff if you've made it this far i would really appreciate you subscribing to the channel to help support these videos and keep them fruitful for the both of us have a great week and i'll see you next time [Music] you

Channel: Tyler McMurray

Views: 2,740

Rating: 4.9470201 out of 5

Keywords: BDCs, business development company, business development companies, how to invest, invest in BDCs, dividend investing, high dividend yield, roth IRA, AFFE rule, BIZD, BDC ETF, BDC Funds, Fund of funds, funds of funds, finance, investing, stock market, M1 finance, dividend growth, private business, invest in private businesses, venture capital, dividend stocks, best dividend stocks, BDC stocks, BDC stocks explained, BDCs explained, BDC, monthly dividend stocks, invest, ETF

Id: QytXai9EfUE

Length: 11min 8sec (668 seconds)

Published: Tue Aug 25 2020