Thanks to four straight years of robust earnings growth, corporate America is awash in cash like never before. Industrial companies included in the Standard & Poor’s 500 index held a record $633 billion in cash as of June 30, according to S&P. That’s up from $500 billion in 2003, and just $155 billion a decade ago. Money is piling up faster than companies can spend it on acquisitions, expansion, stock buybacks and dividends.
That’s creating a problem, albeit a high-class one: how to maximize returns on all this liquidity. Traditional outlets for excess cash - short-term, low-yield investments like money market funds, certificates of deposit and commercial paper - no longer suffice. To capture an extra 10 or 20 basis points of yield, companies are taking more risk.
“A heavy amount of cash can be a drag on earnings,” says Laura Wright, CFO of Southwest Airlines Co. “There’s no question that from a shareholder-return perspective, money market rates won’t do it.” Adds Steve Meier, head of U.S. cash funds at State Street Global Advisors: “There’s been a migration to more-aggressive strategies.”
One surefire way to boost returns is by increasing credit risk. Last year, for example, companies invested 70 percent of their cash portfolios in the highest-quality (triple-A-rated) commercial paper, down from 75 percent in 2004, according to consulting firm Greenwich Associates. At the same time, they increased exposure to lower-quality (A-rated) paper from 4 percent to 10 percent.
Many companies prefer to juice returns with longer-term investments. Capital Advisors Group, a Newton, Massachusetts-based manager of $46.7 billion in cash portfolios, is adding 3 to 5 basis points to some clients’ yields by buying extendable commercial paper, the maturity of which can be increased by the issuer from one month up to 13 months. “On the margin we’re willing to take on liquidity risk for a little more yield,” says Lance Pan, the firm’s director of credit research.
But there are limits to how much companies can improve performance by tying up their money for longer durations. That’s because the yield curve has been relatively flat - even inverted at some points - for much of the past year. As recently as August, one-month U.S. Treasury bills offered higher yields than two-year Treasury notes.
So instead of investing in products with maturities as long as three years (which can be classified as short-term investments, the next-best thing to cash), companies are now opting for portfolios that feature unusually short durations. Fully 81 percent of excess cash on March 31 was invested in instruments with maturities of three months or less, while just 9 percent was allocated to maturities of more than one year, according to consulting firm Treasury Strategies. Last year the split was 69 percent to 21 percent (the remainder in both cases is in maturities of three months to one year).
One way to get around the yield-curve problem is by investing in hybrid instruments called auction-rate securities (ARS) and variable-rate demand notes (VRDN), which feature maturities of up to 30 years but count as short-term investments because their rates are reset at weekly or monthly auctions. Statistics are scarce for VRDNs, but the ARS market has grown from $204 billion at the end of 2003 to $275 billion today, according to Deutsche Bank and the Association for Financial Professionals. Southwest is among the companies that have increased their ARS holdings of late, says CFO Wright. Texas Instruments has 40 percent of its $5 billion cash hoard in ARSs and VRDNs because their yields can beat commercial paper by 25 to 40 basis points. “If you’re going to have a short-duration portfolio, that’s one way to get higher yield,” says TI cash manager Jack Holmes.
But even these investments aren’t magic bullets. Some corporations remain wary, especially since auditing firms last year began counting the hybrids as short-term investments, not cash equivalents. Companies have been pressing the Financial Accounting Standards Board to rule on the matter.
For now, that leaves many corporations with two choices: Come up with more ideas for acquisitions and long-term capital spending that will create shareholder value or remain at the mercy of the yield curve.
