With the Fourth of July just behind us, it's a great time to look at General Motors. I'm not talking about GM's endless "American Revolution" ad campaign -- I'm talking about its revolutionary plan seeking independence from the pension problems that have dogged it for years.
GM has been under fire for its timid strategy when it comes to making and selling vehicles. But it has taken bold and decisive action to try to put its pension problems behind it.
Enter GM's Project Alpha. GM launched Alpha in 2003 with an enormous gamble. It borrowed $13.5 billion with the biggest bond offering ever by a U.S. company and put that money (and $5 billion more from selling its stake in Hughes Electronics) into its pension funds. The Hughes cash was used for the funds' short-term needs; the borrowed cash was earmarked for Project Alpha investments.
Why did GM take the risk of doubling its debt load and committing to pay $1 billion a year in interest? "This allowed us to get ahead of the [pension] game," says GM Treasurer Walter Borst. He says credit analysts were already counting GM's pension shortfall (at the time, around $20 billion by generally accepted accounting principles) as part of its debt load. This way, the company traded that implicit pension obligation for explicit debt with an interest rate of 7.5 percent and an average maturity of 19 years -- far better terms than it would get today, given that its credit rating has been downgraded to junk.
GM says that without the big 2003 deal, it would have had to contribute $3 billion annually to its pension funds. Now it won't have to put in a penny for years. So even after paying interest on its huge borrowing, GM's cash position is $2 billion a year to the good. The gamble looks brilliant now, given how much money GM will have to invest to shore up its U.S. vehicle business.
As a bonus, not having to put money into its pension plan means avoiding a possible conflict with billionaire takeover artist (and big GM shareholder) Kirk Kerkorian about whether to allocate cash to pensions or to such things as paying dividends. You may remember that Kerkorian and his adviser, former IBM Chief Financial Officer Jerry York, fought for years with Chrysler about its use of cash when Captain Kirk was a big Chrysler player. That conflict helped lead to Chrysler's sale -- a lesson that you can be sure hasn't been lost on GM's executives.
Now, to GM's Project Alpha. We're talking geek, not Greek. To financial theorists, alpha means an above-average return without taking more-than-average risk. Not everyone can achieve alpha, of course, just as every child can't be above average, except in Lake Woebegon. But GM, which devotes an entire floor (and 120 people) in its New York City office to pension investing, is one of the best pension investors around.
Allen Reed, head of GM Asset Management, says GM manages all its money actively, rather than following the common practice of investing passively in funds designed to mimic particular indexes. Over time, he says, GM's pension fund has beaten the relevant averages by more than a percentage point a year. That doesn't sound like much, but it's made billions of dollars of difference to GM.
GM won't talk specifics about its Alpha investments, some of which are managed by GM itself while others outsourced to the likes of Goldman Sachs. They're in things like currencies and Third World bonds, hedged portfolios designed to make profits no matter what stocks do. Because GM is using borrowed money for its Alpha investments, it wants lower risk but the same return (9 percent a year) that it expects from the rest of its pension investments.
The theory is that because most Alpha investments aren't tied to the stock market or to one another, the risk of a lot of them going sour at once is relatively low. "In most pension funds, 95 percent of the risk comes from whether equities go up or down, but that's not the case here," says Mark Carhart, co-head of quantitative strategies of Goldman Sachs Asset Management.
GM expects its regular pension assets -- stocks, bonds, real estate and such -- to make 1 percent a year more than the relevant markets. For Project Alpha, the target is 2 to 4 percent more than the market.
Of course, it's not clear if this will work out in the long term. But it is clear that GM's bold gamble has given it a chance to win independence from pension problems. Absent Alpha, it wouldn't have a prayer.
Sloan is Newsweek's Wall Street editor. His e-mail is email@example.com.