The happy, happy crowd is crowing over General Motors (NYSE:GM) once again.
The company, which stared a domestic pension plan underfunded by as much as $19 billion earlier this year, now only has about a $400 million shortfall. The gap was closed quickly through a combination of cash infusions from GM and a rising stock market. GM covered most of the shortfall by taking the fairly extreme measure of issuing more than $13 billion in debt, and will cover several billion more from proceeds of its sale of Hughes Electronics (NYSE:GMH) to News Corp. (NYSE:NWS).
Now we find that GM has set its assumptions for returns on its pension assets at -- get this -- 9% per year. Nine percent. Riiiiiiiiight. That's a pretty steep hurdle for a basket of money totaling more than $100 billion.
The way pension accounting works is that companies get to declare them over- or underfunded based on actuarial inputs that are largely determined by the company. Warren Buffett has called some of the pension assumptions at major American corporations a scandal. And while 9% might not seem that high given the average return of 11% in the stock market over the long term, remember that most pension plans have strict guidelines for composition and must include asset classes that by definition would yield lower than stocks.
It gets particularly difficult for a pool of money the size of GM's to be in stocks; it almost makes no sense for the fund to invest in companies whose market cap is less than several billion dollars. After all, if GM takes the largest position possible at a billion-dollar company, say, Novastar Financial (NYSE:NFI) -- a 5% stake, or $50 million -- and Novastar doubles, the outcome for the overall fund is still just a rounding error. So, big growth opportunities -- an important component of that fabled 11% -- isn't even available to GM's pension. How are they going to do it? According to the Financial Times, GM Asset Management CEO Allen Reed says they will do so by investing in riskier assets, including real estate and foreign bonds and high-yield bonds.
I'm certain that all of the other pension managers around the world are embarrassed that they hadn't thought of this particular strategy before. Trouble is, there is hell to pay for pension funds that destroy their clients' assets, so most refuse to take on larger risks to chase the bigger returns.
We were quite critical of GM's decision to use debt to fund its pension earlier this year; the debt and the servicing thereof will come out of equity in the future and all of the money will have to be repaid. Now, even a component of its Hughes sale will go toward retiree benefits, another company asset that will provide minimal return to shareholders.
We suppose this is a necessary outcome -- pension obligations are in fact obligations. But the second component -- the tacit admission that the fund is still going to have a great deal of difficulty meeting its obligations to retirees without taking on higher levels of risk -- is a bit frightening. I wouldn't be so sanguine that this strategy will get GM out of the woods. After all, as Reed says, if GM were to use a more conservative strategy, the pension fund would not be able to meet its obligations over time.
There is a big, big risk for shareholders that more equity will be necessary to prop up GM's pension.
