US Blue Chips: The New Bond Kings

Record earnings are pushing stock prices to all-time record high, but companies are also sitting with unheralded amounts of cash and bonds on their balance sheets.  Why hold large portfolios of money market instruments and some longer term, highly rated debt securities? Many corporate treasurers have crept further out the risk curve by investing in securities with longer duration and more credit risk than a traditional cash manager. These companies are looking to produce greater returns on their cash accounts by assuming more risk than is traditionally associated with a non-financial company’s liquid assets. Should investors be worried that many large multinational companies are taking more risk in their investment portfolios or is this a reasonable approach to protecting shareholder capital and creating lasting shareholder value?

Companies like Apple, Google, Microsoft, Cisco, Oracle and many other large US firms continue to earn record profits. In recent years, cash flow from operations at these firms has exceeded investment opportunities and current dividend and share repurchase plans. This imbalance has left corporate treasuries brimming with financial assets that dwarf the financial resources of most sovereign nations. For example, in their most recent quarterly filing, Apple reports cash assets of $18 billion, short-term marketable securities of $58 billion, and long-term marketable securities of $184 billion. This is a liquid portfolio in excess $260 billion, a sum larger than the assets managed by most institutional money managers. If it were a mutual fund, Apple’s bond portfolio would be the largest single bond fund in the world (Vanguard’s Total Bond Market Index fund, the current largest bond fund open to investors, manages $188 billion in assets). Apple and many peers have amassed gigantic bond portfolios. Just three companies, Apple, Alphabet (Google’s parent), and Microsoft, control portfolios of a combined half trillion dollars across a variety of fixed income investments, a staggering figure in aggregate.

Apple’s hoard of cash and securities has become the target of some outspoken activist investors over the past few years, putting management on the defensive. These shareholders justifiably argue that Apple should reward shareholders who are the beneficial owners of this $260 billion portfolio. Apple hasn’t totally ignored these demands, but it also hasn’t slowed the growth of its securities portfolio. The board continues to increase the dividend and has dedicated more capital toward repurchasing shares, but not at a level greater than the firm’s internally generated free cash. Despite shareholder laments, management argues that they are behaving responsibly, by investing a portion of liquid capital resources in less traditional fixed income sectors to maintain a liquid cash portfolio. Investing in a broader array of fixed income assets allows a formerly inert asset (cash) to earn excess return and gives corporate managers time to wait for large scale opportunities in which to invest. This argument falls flat, based on recent history. Apple hasn’t made any acquisitions large enough to make a dent in their cash pile in the past ten years.

Apple’s recent condition is not unique. Many large corporations, mainly tech companies, are finding it difficult to find enough worthwhile projects to finance internally or acquisitions large enough to slow the growth of their investment portfolios. Furthermore, global companies organized in the US are unable to use all of their foreign earnings without paying corporate taxes on cash brought back home from profits at overseas subsidiaries. This repatriation tax limits the amount of cash available to fund returns to shareholders. Because of this, global companies return cash to shareholders by borrowing in debt markets. Apple currently has more than $89B in debt outstanding, making it one of the largest global corporate issuers.  Capital allocation plans at these companies are constrained by the size of the corporate bond market. The aggregate demand of corporate bond investors actually isn’t large enough to accommodate the demands of their shareholders. Therefore, without a repatriation tax holiday, which would allow for a large special dividend or an even larger share repurchase program using assets currently held overseas, the portfolio of cash and liquid assets at these companies will grow. These non-financial companies are likely to remain large players in financial markets for years to come.

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