5 Great BDCs To Make The Most Of A Rising Rate Environment

After years of soft interest rates, investors are slowly being confronted by a firmer rate environment. This clearly shows in the market’s fear gauge, the CBOE Volatility Index’s recent six-month high. Further, the S&P 500 plummeted 10% before picking up.  And with the Fed intent on raising rates this month, things will only get tougher for equity markets.

However, it isn’t that rates are detrimental for stocks of all classes. One class of companies which gains when rates rise is business development corporations (BDCs). Not only do BDCs pay out an average dividend of nearly 10%, they also act as a buffer against rising rates. This is why they would make great additions to your portfolios at this point in time.

Why Do Rising Rates Drag Down Stocks?

The Federal Reserve has raised rates thrice this year and is set to announce another hike in December. The yield on the 10-year Treasury bond has increased by more than 100% since 2016 and recently hit a seven-year peak. Firmer rates are in the end the outcome of a booming economy. Under such circumstances, rates can only go up.

For years, investors and companies have become used to a soft interest rate regime. Corporations have borrowed on the cheap, enabling them to finance their expansion at low costs. However, they are now faced with a spike in rates. This makes it tough to finance operations and service existing debt.

This is why higher rates push down company earnings and ultimately drag share prices lower. Ultimately, this has a widespread impact on broader equity markets. Per a study by Bridgeway Capital Management, the long-term average gain of the S&P 500 in a soft rate regime is 13.3%. However, when rates climb, this return is slashed by nearly half.

Why BDCs Prosper When Rates Climb

BDCs usually invest in privately held small to mid-sized businesses. Companies suffering from financial distress are their primary targets. In a sense, they are similar to venture capital funds, which are open only to institutional investors.

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