Strategy Review

The Strategas Repatriation Basket (the basket) identifies the top 25 companies that would benefit from repatriation while controlling for company market capitalization. We believe it is important to control for size because, following the repatriation holiday in 2005, companies that repatriated the most overseas cash in aggregate did not outperform the S&P 500®. However, those that repatriated the most relative to their size significantly outpaced the index.[1]

Although a repeat of this performance pattern is not a guarantee, it seems logical to us; that is, companies that are repatriating the most, relative to their size, have the most to gain from the legislation change.

The basket was added to the platform at the end of April 2017; performance can be seen below through the end of November 2018.

(Table 1) Repatriation Bank Performance Summary:

Period

Repatriation Basket

S&P 500

YTD (thru 11/30/18)

5.51%

5.10%

Q3 2018

6.99%

7.71%

Since added to platform*

13.22%

19.49%

*End of April 2017 through 11/30/18  |  Source: PNC

 

Strategy Guidance & Company Repatriation Updates

Using a similarly constructed basket of stocks during the 2005 repatriation tax holiday as a guide, the more consistent outperformance of the basket began after the bill was officially signed into law. Similarly, 2018 year-to-date performance continues to outpace the S&P 500 by 41 basis points as companies have received further clarity of the repatriation tax rules (finalized in August 2018). The strategy continues to trail the S&P 500 since being added to the platform, mostly due to poor performance in fourth-quarter 2017 as investors speculated that tax reform may not pass.

The Tax Cuts and Jobs Act, which went into effect at the beginning of 2018, imposed a one-time tax on companies’ unremitted foreign earnings, thereby allowing companies to repatriate their overseas earnings back to the U.S. Through the first half of the year (latest data available) companies have repatriated $465 billion in overseas cash according to the Bureau of Economic Analysis (BEA) largely outpacing expectations considering final IRS guidance had not yet been released (Chart 1).

In our view, a conservative estimate for total dollars ultimately repatriated is between $600 million and $700 million this year, with approximately another $1 trillion of cash available for repatriation.

Again using the 2005 repatriation as a guide, there was about $600 billion of overseas cash and companies chose to repatriate $300 billion. The “deemed repatriation” component of the tax bill may further encourage companies to bring back a larger portion (relative to 2005) this time because they are forced to pay tax on all of their overseas cash (whether they actually bring it back to the United States or not).[2] However, as a result of the eight-year payoff window of the deemed repatriation tax, companies may choose to bring back overseas cash over a number of years. Thus, it is possible the pace of repatriation slows in the coming year.


 

Strategy Holding Period

The strategy’s investment thesis continues to be valid, in our view; however, the ability to accurately reconstitute the portfolio has diminished. As a reminder, each year the constituents of the basket were to be examined based on the amount of cash yet to be repatriated. Companies that still had large amounts of cash overseas would replace companies in the portfolio that had already repatriated such funds. As reporting requirements evolved post-tax bill, companies are now no longer required to specifically report profits being held overseas. Given the new territorial tax system, this reporting requirement became less important. With third-quarter earnings season complete, companies have continued to be relatively opaque regarding overseas cash[3]. As a consequence, the annual reconstitution of the portfolio becomes far more difficult, and in our view, reduces our ability to extend the holding period. Again, the strategy is still sound, but going forward it will be much harder to identify the companies still holding large amounts of cash overseas.

Typically the basket is reconstituted shortly after the end of the first quarter each year based on overseas cash positions and market capitalizations. As stated, we continue to see companies repatriate overseas cash; however, determining which companies continue to hold the highest percentage of overseas cash relative to their market capitalization, as per the basket’s reconstitution methodology, is no longer a straightforward exercise. Given the baskets outperformance year to date and the portfolio reconstitution challenges, we believe it makes the most sense to exit our repatriation allocation at the end of 2018/early 2019 prior to the next normal basket reconstitution date.