Most portfolios are quietly short inflation. People don’t think of it that way, but it’s true. A long bond, a growth stock priced on cash flows a decade out, a pile of cash earning less than CPI — all of them lose ground when the price level rises and stays risen. The question I keep coming back to is a simple one: what do you own that actually gets better when inflation shows up, rather than just less bad?

There are a few honest answers. Three of them are BDCs, MLPs, and — with an asterisk I’ll get to — REITs. Each one is a real-asset or real-rate exposure wearing a different costume. Let me take them in order, because the order matters: the first two are cleaner hedges than the third, and the reason the third is cheap is the same reason it’s only a partial hedge.

BDCs: getting paid more as rates rise

Start with business development companies. A BDC is, in plain English, a publicly traded pool of loans to middle-market private businesses — the companies too big for a bank’s small-business desk and too small for the public bond market. You buy a share, you own a slice of a diversified private-credit book, and the income gets passed through to you.

Here’s the part that makes them an inflation hedge rather than an inflation victim: most of those loans are floating rate. They’re priced at some benchmark short rate plus a spread. When inflation runs hot and the Fed pushes short rates up to fight it, the interest the BDC collects resets higher — automatically, loan by loan, as the benchmark moves. The asset’s income climbs with the very thing that’s eroding your other holdings.

Compare that to a long-term bond, which does the opposite. The bond’s coupon is fixed; when rates rise, its price falls and its real income shrinks. A floating-rate loan book is the mirror image. That’s the whole appeal.

Be honest about the cost, because there always is one. The thing that makes a BDC’s income rise with rates — lending to smaller, more leveraged businesses — is also the thing that puts that income at risk in a recession. Higher rates eventually pinch the borrowers too. Credit losses are the real risk here, and they show up exactly when the economy turns. So the question with any BDC is never just “what’s the yield?” It’s “who underwrote this book, how have they done through a real downturn, and are they being paid enough spread for the credit risk they’re taking?” A high yield on a badly underwritten book is not income — it’s a return of your own capital with extra steps.

MLPs: toll roads with inflation built into the contract

Now the second one. Master limited partnerships — the midstream energy kind — are essentially toll roads for hydrocarbons. They own the pipelines, the storage tanks, the processing plants that move oil and gas from where it comes out of the ground to where it gets used. They don’t, for the most part, bet on the price of the commodity. They get paid for the volume that moves through the pipe, on long-term contracts.

The inflation link sits right in those contracts. A lot of midstream tariffs — the tolls — are tied to an inflation index by formula. The FERC oil pipeline index, for one, adjusts allowed rates by a measure of inflation each year. So as the price level rises, the toll the pipeline is allowed to charge rises with it, more or less mechanically. You own a hard, irreplaceable real asset — you cannot easily build a new interstate pipeline — collecting a toll that escalates with inflation. That is about as direct a real-asset hedge as exists in public markets.

Two honest caveats. First, the tax form. Most MLPs send you a K-1 instead of a 1099, which is more paperwork and can create complications inside a retirement account — there’s a thing called UBTI that can make MLPs a poor fit for an IRA. That’s not a reason to avoid them; it’s a reason to hold them in the right account and know what you’re signing up for. Second, these are levered businesses in a capital-intensive industry, and they’re tied to energy volumes — if the long-run demand for what flows through the pipe falls, the toll road matters less. The contract protects you against inflation. It does not protect you against obsolescence. Underwrite both.

REITs: the cousin that needs an asterisk

Here’s where I have to be more careful, because the easy version of this story is wrong.

The bull case for real estate as an inflation hedge is real: buildings are hard assets, replacement costs rise with inflation, and many leases reset rents upward — some with explicit CPI bumps, and short-lease property types like apartments and hotels reprice every year just by turning over tenants. Rent is, in a sense, the price of shelter, and shelter is a big chunk of inflation itself. So on the asset side, REITs belong in this conversation.

But there’s a second force working the other way, and it’s the reason I treat REITs as the more balanced — read: more complicated — member of this group. Real estate is valued, in large part, off the level of long-term interest rates. When rates rise, the cap rate the market applies to a building’s income tends to rise too, which pushes the building’s value down even as its rents are climbing. Two opposing forces: rising rents on one side, rising discount rates on the other. Which one wins depends on the property type and the lease length.

That tension is precisely why a good slice of the REIT universe looks cheap right now. The market has spent the last couple of years marking real estate down for higher rates — the discount-rate force — and in plenty of cases it has overshot, pricing in stress that the underlying rents and occupancy don’t support. That’s where the value work lives. The distinction I care about most is lease length:

• Short-lease, repricing property — apartments, self-storage, hotels — resets rents quickly and is the closer thing to a genuine inflation hedge. The income chases the price level.
• Long-lease, net-lease property — a building leased to a single tenant for fifteen years at a fixed bump — behaves much more like a long bond. Its cash flow is locked, so when rates rise it gets hit like a bond gets hit, and it hedges inflation poorly.

So “REITs hedge inflation” is too blunt to be useful. Some REITs hedge inflation well; others are long-duration bonds dressed up as real estate. The cheapness you see in the sector is partly a fair repricing for higher rates and partly an overshoot — and telling those two apart, name by name, is the entire job.

The thread that ties all three together

Step back and the common mechanism is clear. Each of these owns something real — a loan book that reprices, a toll road with an escalator clause, a building with rising replacement cost and resetting rent — and in each case the income or the asset value has some structural tendency to climb with the price level. That’s what an inflation hedge actually is: not a promise, but an exposure whose cash flows lean the right way when inflation arrives.

And notice that none of this replaces the work. A floating-rate hedge wrapped around a badly underwritten loan book is a trap. A toll road headed for obsolescence is a melting ice cube with a nice tariff formula. A “cheap” REIT might be cheap because its leases are long and its real hedge is illusory. The inflation characteristic gets these onto the shopping list. Whether any individual name belongs in a portfolio is still a question of business quality, balance sheet, management, and — always — the price you pay against what it’s worth.

Inflation protection is a feature you want. It is never, by itself, a reason to own something.

The bottom line

If you’re worried that your portfolio is quietly short inflation — and most are — BDCs, MLPs, and the right REITs are three of the few places to do something about it without abandoning a value discipline. BDCs give you income that resets up with rates. MLPs give you a real asset collecting an inflation-linked toll. REITs give you hard assets and resetting rents, balanced against the rate sensitivity that explains why parts of the sector are on sale. The first two are cleaner hedges; the third pays you to do more homework.

The homework is the point. Own the inflation characteristic, yes — but own it inside a business you’d want to hold anyway, bought at a price that gives you a margin of safety. That order never changes.

If you’d like to talk through how we think about positioning a portfolio for a higher-inflation world, schedule a conversation with us.