Corporates held hostage to proxy bonds

Lower interest rates are forcing companies to become slaves to yield-hungry investors, paralysing investment as risk is shunned in an effort to simulate bonds.

By Kirstie Spicer · 31 Oct 2013

By Kirstie Spicer ·
31 Oct 2013

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Capital flows have been leaving the bond market and finding sanctuary in the equity market. Although not any type of equity will satiate investors, dividend payers – essentially those that can behave like a bond proxy – are favoured. Capital growth is not the aim of the investment.

Investor expectations are pressuring companies to increase dividends or buy back shares, with an end goal forcing companies to ultimately be risk averse. The pressure has been so great the US market is actually shrinking, with estimates that 10 per cent of the market cap from a few years ago has been bought back by companies.

Low interest rates are almost being harmful, according to Rob Buckland, Global Equity Strategy Managing Director at Citi. Not in the sense of quantitative easing artificially propping up equity markets, but rather lower interest rates forcing companies to be a slave to yield-hungry investors. The theme of Buckland’s analysis on the flow of capital and resulting effect is that shareholders have become so insistent on finding quality companies with a steady cash flow they are prohibiting companies from being, well companies.

There is a sense of risk aversion among shareholders in the current investment landscape. Capital flows suggest these investors would prefer bonds, but with negative real interest rates on offer in this sector of the market, investors are forced to look elsewhere.

Economically there are consequences as companies stop spending to please their yield-hungry investors. Companies are halting capital expenditure and sacking workers to dial down the risk and appeal to investors seeking a greater emphasis on income as opposed to capital growth. Increasingly demanding investors expect rising cash-focused returns at the same time as squashing any plans for capital investment.

This thematic is slowly creeping up on Australian companies and is much more prevalent internationally. Carl Icahn, a successful corporate raider and investor activist, is also a recent investor in Apple and has been very vocal in demanding Apple borrow $US150 billion to buy back shares from investors in a bid to unlock value. Icahn even wrote a letter to chief executive Tim Cook explaining this.

Unfortunately Icahn’s justification of low interest rates for the strategy may be flawed for Apple investors with a long-term approach. There is an element of risk borrowing a large sum when future cash flows are uncertain. Apple’s next product might not be a revenue generator equivalent to the iPhone.

Good financial management of a company involves saving cash when times are good for the down times that invariably come. Investor pressure today could crimp the future profitability of today's favoured high-yielding stocks.

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Corporates held hostage to proxy bonds

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