Income investors are facing challenges this year. The Federal Reserve’s rate tightening campaign is punishing bonds, but real yields on high quality debt remain low.
In other words, it could pay to examine alternative sources of income, including private credit. Enter the Virtus Private Credit Strategy ETF (VPC ). VPC follows the Indxx Private Credit Index, which provides exposure to private credit-focused assets such as business development companies (BDCs) and closed-end funds.
Currently, there’s momentum in the private credit arena as more advisors and investors are looking to tap higher-income, less rate-sensitive assets.
“The space is continuing to experience a wave of attention as faith in private credit has grown through COVID and investors seek additional alpha opportunities given traditional bonds rolling over and having one of their worst runs on record as rates march higher,” noted Virtus.
Today, VPC is heavily allocated to BDCs, which makes sense because a significant portion of the private credit market revolves around loans and debt financing extended by companies that aren’t traditional banks. Often, those types of financing are sought by companies that are ignored by standard banks, creating a lucrative market for BDCs.
“The BDC industry continues to mature and institutionalize, becoming a competitive destination as the demand for yield continues. Relatively cheap debt has been providing a boon to BDCs’ portfolio companies; BDCs have been taking advantage of the sea of liquidity by refinancing and extending maturities,” added Virtus.
Adding to the allure of VPC in the current market environment is the point that private credit investments, including BDCs, are supported by floating-rate notes (FRNs) — one of the least rate-sensitive corners of the bond market.
That’s one reason why although BDCs are high yield assets, which in theory makes them vulnerable to rising rates, broad baskets of BDCs are outperforming standard equity benchmarks by healthy margins this year. Speaking of healthy, that’s an accurate way of describing BDC’s balance sheets, indicating that these firms can support payouts while capitalizing on new opportunities.
“The largest, most diverse and highly capable, publicly traded BDCs continued market share gains and consolidation of the industry,” concluded Virtus. “Additionally, they are well capitalized and exhibit improved leverage and liquidity profiles, allowing them to take advantage of ever larger investment opportunities. While yields have come down since the start of the pandemic, due to a meaningful recovery of economic growth, fundamentals remain strong and dividend yields remain attractive in the current rate environment, especially as it relates to the broader bond market.”
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