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Big Buyers Of Corporate Bonds: Other Corporations

Companies reaching for better returns on their cash have found a new favorite investment—other companies’ bonds—and they are loading up.

More than half of corporate cash held by U.S companies this August was invested in investment-grade corporate bonds, a record, according to investment-software company Clearwater Analytics. Meanwhile, treasurers have reduced their companies’ holdings of more traditional investments such as U.S. Treasurys, commercial paper and bank certificates of deposit.

Companies are betting highly rated corporate bonds are safe repositories for cash that will pay higher rates than more traditional bank deposits or money-market funds. But they are also increasing the risk to an asset where principal protection is the priority.

If interest rates rise quickly, the value of their lower-yielding existing bonds could plummet. A major market disruption could also make it difficult for companies to sell their holdings if they need the cash. Either could lead to write-downs or actual losses if they sell at lower prices than they paid.

For now, treasurers are figuring the bet isn’t that risky. Companies’ balance sheets are in good shape, and buyers are focusing on bonds that mature within five years, which carry lower risks than bonds that take longer to mature.

Still, the past offers plenty of examples of companies that got burned when reaching for yield. Procter & Gamble Co. lost more than $100 million after it bought derivatives from Bankers Trust Co. in 1993 in an unsuccessful bet that interest rates would remain low. MetroPCS Communications Inc. wrote down millions in investments in 2007 because it invested in auction-rate securities and couldn’t sell the holdings. Even mainstream investments can have hiccups in tough times. After Lehman Brothers...