One Good Idea: Buy Brookfield Asset Management bonds

These yield-rich bonds are backed by a diversified business that has a lot of cash

By Dianne Maley
Globe Investor Magazine online, December 19, 2008

The Source: Brian Eby, partner, Connor Clark & Lunn

The Idea: Buy Brookfield Asset Management Inc. bonds.

At an eye-popping 10.6 per cent, the yield on Brookfield's 5.29 per cent bonds maturing April 25, 2017, is hard to pass up, Mr. Eby says. U.S. government bonds of the same maturity are trading at less than 3 per cent, he notes.

"The difference is extraordinary."

The reason for such a wide spread is the flight to the safety of U.S. Treasuries. Investors, shying away from the plunging stock market, are turning their back on corporate bonds regardless of the quality, fearful of even the faintest hint of risk.

They want the full backing of the U.S. or Canadian government before they are willing to part with their money because any corporation could default on its debt.

"All corporate bonds are extraordinarily attractive right now," Mr. Eby said in an interview.

He gives the following example: If you were to invest passively (through an index fund) in a portfolio of investment grade five-year corporate bonds and hold them for five years, you'd need to have a default rate of more than 40 per cent to be worse off than if you held a portfolio of U.S. Treasury bonds, with their low returns, for the same duration.

During the Great Depression between 1931 and 1935, the default rate on U.S. investment grade debt was only 4 per cent.

With Brookfield, it is difficult to imagine the company running into financial problems, Mr. Eby says. Brookfield had $3.5-billion (U.S.) in cash and other liquid assets at the end of the third quarter, and its operating cash flow was up 45 per cent from the previous year. Its refinancing requirements are $2.7-billion through to 2010.

"They generate $1.5-billion in annual cash flow," Mr. Eby notes. "The liquidity situation is very strong."

The bonds are trading at $71 (Canadian) and are rated single A low by Standard and Poor's and Dominion Bond Rating Services.

Brookfield Asset Management is in four key areas: power generation, infrastructure, real estate and timberlands, with the infrastructure business being the most attractive, he says.

What about its Manhattan office towers, including the World Financial Centre, which Brookfield picked up from Olympia & York Developments when it went broke in 1992? Commercial real estate is likely to be hurt by the recession, particularly in financial services.

Mr. Eby says Brookfield has a sufficient cushion -- its rents could drop by 25 per cent with 100-per-cent lease turnover and its cash flow would still remain flat. Its actual lease renewals are less than 5 per cent a year for each of the next four years.

The Payoff: An extra seven-and-a-half percentage points or so in yield for the next eight years with very little risk.

The Big Risk: As with any bond, inflation could shoot up, pulling interest rates with it and knocking down the value of existing bonds. "That's not something I'd be terribly concerned about right now," Mr. Eby says. The inflation risk rises with the bond's term.

As well, corporations can default on their debt, a situation he considers highly unlikely in the case of Brookfield Asset Management.

Why listen to Brian Eby?

Mr. Eby, who has been in the business since 1985, is manager of the fixed income group at Connor Clark & Lunn, with $7.5-billion in mostly fixed income assets under administration, mainly for institutional clients.

- Special to The Globe and Mail