For 14 years, the federal funds rate has hovered around zero. The Federal Reserve or “Fed” maintained these low rates to stimulate the economy during two steep market downturns: the 2008 Great Recession and the 2020 COVID-19 pandemic sell-off.
But, the economy has recovered since those events, and prices are rapidly increasing from record-high inflation and other factors. The Fed has drastically increased rates since January 2022 to slow down inflation and lessen the impact that a recession would have.
Despite this, business development companies (BDCs), real estate investment trusts (REITs), and master limited partnerships (MLPs) pay much higher than average yields and can perform well during rate hikes.
BDCs provide capital to small, upcoming businesses in the initial stages of their development in exchange for high rates of interest or equity stakes. Basically, they’re lenders to fast-growing, high-risk startups.
It’s not uncommon to find BDCs that yield 10%, 11% or 14%. For example, FS KKR Capital Corp. FSK has yielded an impressive 14% in the past.
Many BDCs benefit from increasing rates since this lets them charge higher rates to their borrowers. For example, Ares Capital Corp. ARCC, one of the largest publicly traded BDCs, is projected to earn an additional $10 million in net income with every rate increase of 100 basis points or 1%.
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REITs let you invest in real estate without the headache of being a landlord or saving for a high down payment. Equity, debt and hybrid REITs comprise the three main types of REITs.
Regardless of the REIT type, these types of investment can provide diversification, a hedge against inflation and above average yields. REITs can also perform well during high inflationary times since property values, rents and interest rates on loans to borrowers tend to rise with inflation.
Similar to BDCs, REITs don’t pay corporate taxes if they pay out at least 90% of net income in the form of dividends. Some REITs like WP Carey Inc. WPC, Global Medical REIT Inc. GMRE and Ready Capital Corp. RC have had yields in the past that range from 5% to 14%.
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An MLP is a business entity that many companies use to receive tax advantages, which let them pay out high yields. Many MLPs greatly stimulate the economy by investing in the oil, gas and real estate industries.
MLPs must derive 90% of their revenue from natural resources, commodities or real estate to avoid paying corporate taxes.
Many MLPs like Magellan Midstream Partners MMP, Energy Transfer LP Unit ET and Enterprise Products Partners EPD have demonstrated past yields ranging from 7% to 9%. MLPs tend to do well during high inflation and rate hikes since they have exposure to tangible assets like real estate and energy. Both real estate and oil prices can easily keep up with or exceed the rate of inflation.
For example, Energy Transfer is up 24% since the beginning of the year and has an impressive 7.4% yield. On the other hand, the S&P 500 has realized double digit losses during that same period.
Expand Opportunities with BDCs, REITs and MLPs
Interest rates have been kept artificially low for more than a decade. Inflation and the possibility of recession have led the Fed to raise rates since the beginning of the year. During this time, many indexes like the S&P 500, Dow Jones and even cryptocurrency have realized staggering losses. BDCs, REITs, and MLPs can be high performers during times of high inflation and significant interest rate increases.
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