from Follow the Money

The China-Once-Again-Investing Corporation

June 10, 2009

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Sundeep Tucker of the FT (drawing on work by Z-Ben advisors) reports that the CIC is ready to allow its external managers to start buying equities:

Early last year CIC picked two or three fund management groups for each of six investment mandates, four equity and two fixed income, with an aggregate sum of $12bn. Only the global fixed income mandate was funded before the shutters came down. The managers of the remaining five mandates have just been notified that they are finally about to be funded, in stages, over the coming weeks. A public announcement is expected imminently, according to Z-Ben Advisors, a Shanghai-based consultancy.

Z-Ben says CIC has also earmarked a further $30bn of its liquid assets for passive mandates, which will also be handed to global portfolio managers over the next 6 to 12 months.

Tucker suggets that the CIC’s decision to ”fund” its external managers is a reaction to the difficulties Chinese firms have faced taking large stakes in Western oil and mining companies. I am a bit skeptical that the connection is that direct. Not unless the CIC was helping to finance Chinalco’s investment, which really would be news.

No doubt Chinese officials are frustrated that “their companies” haven’t been able to complete some high profile transactions. On the other hand, the heavy hand of China’s sate in China’s outward investment was always going to make it difficult to convince other countries that outward investment from Chinese firms is motivated purely by commercial concerns. Call it a cost of an exchange rate regime that gives China’s state a de facto monopoly on most of China’s outward investment.

More importantly, though, China simply doesn’t face the same constraints as countries whose reserves barely cover their external debts and have to maintain a fairly liquid portfolio. The foreign portfolio of China’s government is so large that it really doesn’t really have to pick and choose among strategies. It can do a bit of everything.

SAFE – counting the PBoC’s other foreign assets – and the CIC have between $2.2 and 2.3 trillion to invest abroad. The state banks have a sizeable pool of foreign currency (their foreign assets top $200 billion) as well. Chinalco can easily borrow $19 billion (or more) from the state banks even as the CIC hands roughly $40 billion over to external fund managers to invest. And the CIC can increase its exposure to equities even as SAFE nurses the wounds it incurred after investing $150-200 billion (my estimate) of China’s reserves in US, European and Australian equities before global stock markets turned south.

Chinalco’s (proposed) stake in Rio and the CIC’s new investments together total around $60 billion. There were months last year when China’s reserves grow by more than $60 billion. China simply operates on a different scale.

For the past few months, the main constraint on Chinese outward investment were largely self-imposed. China was so afraid of losses that it did little other than buy Treasuries. That does seem to be changing.

As a result, the rest of the world increasingly will have to assess when type of assets Chinese state companies – including companies that want both to make a profit as they support Chinese state goals -- can buy. And that China will likely need to decide on the CIC’s role.

The CIC has always been more than simply a portfolio manager. Don’t forget, the CIC formally holds the states’ stakes in the state banks, and the state banks are often used as tools of policy. Including now – when they have been asked to lend without too much consideration of future losses (see Andrew Batson in the Wall Street Journal). Having the CIC manage this stake solved an internal political problem – as it avoided handing the state’s (valuable) stake in the banks over to either the PBoC or the Finance Ministry. But it also made it difficult for China to argue that the CIC was a pure portfolio manager interested solely in returns.

Then again, the crisis has blurred the line between a sovereign wealth fund that invests abroad and a domestic bailout fund in a host of countries.

It has long seemed, though, that the CIC’s initial round of bad investments and then the crisis prevented a clear resolution of China’s internal debate over the CIC’s ultimate mission.

Is its role simply to pick the right external managers for a portion of China’s portfolio?

Or is it going to be a strategic partner for Chinese firms looking to invest abroad and – perhaps -- foreign firms looking for a leg up in China?

Is it going to be as transparent as Norway’s sovereign fund? Or would it prefer to keep its activities secret in an effort to avoid scrutiny at home and abroad?

Transparency means fessing up to losses - -and after the public outcry over the CIC’s highly visible losses on Blackstone and Morgan Stanley, the CIC may well place a high priority on avoiding investments where any CIC losses would quickly become visible.

On the other hand, if the CIC is going to invest heavily in index funds – a quite reasonable strategy, and one that raises few political problems abroad – there isn’t much reason for the CIC not be transparent about the management of its external portfolio. That would help to dispel any suspicion that the CIC is being used to help Chinese state firms.

Tucker notes that China is drawn to private equity funds and hedge funds because of their lack of transparency (“There is also rising chatter that CIC and Safe will hand additional monies to hedge funds and private equity firms, neither of whom typically need to declare the source of their financing”) . Interesting. * But also not the best sign.

In some ways though it may not really matter.

The CIC was never going to be the only agent investing Chinese state funds abroad; nothing keeps other institutions from following different strategies than the CIC. And in a world where the lines between the state and the market aren’t as clear as they once were, the number of state investors with mixed motives has soared. The US government (via GM) and Russia’s government (via Sberbank) could soon be joint owners of a car company (Opel) that has most of its operations in Germany. Talk about a strange world.

One administrative note: I am tied up a conference today, and thus my usual analysis of the US trade data will be somewhat delayed.

* During the debate over a code of conduct for sovereign funds, many sovereign funds claimed that they shouldn’t be subject to higher standards of transparency than private pools of capital. That argument was always a bit disingenuous, as many sovereign funds were large investors in less-than-transparent private pools of money. And they weren’t exactly using their clout to push for more transparency.

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