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updated 12/22/2003 12:35:42 PM ET 2003-12-22T17:35:42

Poof! As if with a magic wand, General Motors has erased the $17.8 billion gap it had in its U.S. pension funds a year ago. By the end of 2003, the No. 1 automaker says its retirement plan for U.S. hourly and salaried workers will be nearly fully funded. That's great news for investors, as it will cut GM's expenses next year by about 70 cents per share.

There was no magic potion or sneaky accounting involved--just smart money management. So why, then, is GM changing its investment strategy now?

General MotorsDetroit's Pension GM's $17 Billion Bargaining Chip It's simple, really, says Morgan Stanley automotive analyst Stephen J. Girsky. "Once you get fully funded, the idea is to minimize the risk, so you don't go back and relive this nightmare."

GM's pension deficit, the largest facing any U.S. corporation, was a drag on the company's earnings and credit rating. With more than two retirees for every active worker today, GM has been paying out about $6 billion a year in pensions, putting a strain on its liquidity.

But thanks to the recent stock market recovery, along with a well-timed debt offering last summer, the picture has improved dramatically.

GM has contributed $14.4 billion to its U.S. pension funds so far this year, much of it from a recent $13.5 billion debt financing. It plans to contribute another $4.1 billion before the end of the year, assuming its pending sale of Hughes Electronics to News Corp. wins the necessary government approvals. News Corp. struck the deal for Hughes earlier this year after antitrust regulators refused to approve GM's earlier deal with EchoStar.

During 2003, GM earned a tidy 18% return on its pension fund assets. But in 2002, it lost 7% (still better than the equity markets as a whole, which were down 21%). Now that the plan is fully funded, GM's goal is to minimize that volatility to earn a consistent 9% a year.

Historically, GM's pension assets have been split among the following investments: 55%-60% equities, 30%-35% bonds and 10%-15% other assets.

GM's new strategy is to shift more of its pension funds into asset classes that aren't as closely linked to overall market performance. Instead, these investments would rely more heavily on active management--things like emerging market equity and debt funds, domestic high-yield bonds, small cap equities, real estate and private equity.

GM says the change will further diversify its pension portfolio while reducing global equity allocation to less than 50%.

With the pension fund under control, GM says the next big issue is trying to whittle down the deficit in its health care fund for retirees, which stood at a whopping $54 billion at the end of last year. GM won't provide an updated estimate until January.

But one thing's certain: GM is unlikely to use additional spin-offs such as Hughes to raise cash for retiree health care. Says Chief Financial Officer John Devine: "We're pretty much down to an auto company here, and that's what we plan to keep for the foreseeable future."

© 2012 Forbes.com

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