Brookfield Residential Properties, with a 6.5% coupon and 5 years to maturity, could be purchased at about $90 in early 2016. A buyer would earn in excess of a 6.5% coupon yield in addition to about 2% annual appreciation to face value. Even modest appreciation is of great value to an income investor, since without it, inflation exacts a serious cost over time in the form of loss of purchasing power.

In a 1% interest rate environment, one should not have received that premium yield, given both the substantial underlying value of Brookfield’s land portfolio and its relatively unleveraged balance sheet. However, these bonds were originally issued as Rule 144-A (unregistered) securities for direct sale to institutional investors, and were therefore originally unavailable to individual investors or ETFs. Moreover, Brookfield Residential is a small company. However, it is wholly owned by a very large, very creditworthy parent, Brookfield Asset Management, such that in practical terms we judged this to be an excellent credit. The institutional limitations that kept the bonds outside the circle of index and mutual fund demand, led to a mispriced yield that well exceeded that of the U.S. high yield index.

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