from Follow the Money

SAFE, SWF

April 3, 2008

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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SAFE is China’s State Administration of Foreign Exchange, the body charged with managing the bulk of China’s reserves. It generally isn’t considered a sovereign wealth fund (SWF). Central banks generally manage a portfolio of safe, liquid assets -- government bonds and the like. Some do invest in equities, but generally they prefer equity index funds and the like.

Sovereign funds by contrast are willing to take large and illiquid stakes in companies in the hope of getting better returns.

The line though isn’t all that clear -- some aggressive central banks hold a riskier portfolio than some conservative sovereign funds.

And there are growing signs that the State Administration of Foreign Exchange is becoming more aggressive. It has bought a set of stakes in Australian companies. It recently indicated that it had bought a sizable stake in the French oil company Total. The latest US capital flows data also suggests a meaningful increase in China’s purchases of US equities. That increase preceded the formation of the CIC, and best I can tell, most of the ongoing purchases are coming from SAFE not the CIC. Until it gets the last tranche of its initial round of funding (something that should be marked by a noticeable fall in China’s reserves), the CIC doesn’t actually have all that much money to invest -- most has already been committed to Huijin, China Development Bank, Blackstone and Morgan Stanley.

SAFE’s growing willingness to take risks isn’t a total surprise -- it already has way more liquid assets than it needs, and it was reasonably clear when I visited Beijing that SAFE views the CIC as a rival. SAFE likely wants to show that it can invest as well as the CIC, at a far lower cost. China’s central bank doesn’t want another agency to take over the management of too many of China’s foreign assets.

But SAFE’s new policy also raises a host of issues -- both for China and for the world.

China’s authorities have to worry that the CIC and SAFE may end up bidding against each other. And, as the FT (McGregor, Hollinger and Sender) notes, SAFE’s investments are likely to raise almost as many concerns as the CIC’s:

SAFE’s more aggressive investment posture in the wake of the setting up of CIC has caused divisions at the top of the Chinese government, because of concerns that two agencies could be competing in what is already a sensitive area for Beijing.

CIC’s attempts to establish itself in the global investment community as a transparent and independent investment entity – a challenge, given the focus both on China and sovereign funds generally – is also being damaged by SAFE’s new assertiveness, Chinese officials said.

The CIC’s total foreign portfolio is still small -- and it will remain relatively small even after it gets its second $100b. Two-thirds of its initial $200b have been committed to the domestic banks.

SAFE by contrast is huge. And its assets are growing incredibly fast. Judging from January and February data, the annual increase in China’s reserves is now bigger than Russia’s total reserves -- and roughly equal in size to a reasonable estimate of ADIA’s portfolio.

And ADIA (the Abu Dhabi Investment Authority) is the world’s largest sovereign fund.

My guess is that the reallocation of SAFE’s portfolio is still quite modest. $5b a month in equity purchases would still leave roughly $45b a month for bond purchases. If that ratio ever reverses itself, watch out.

With China’s foreign assets rising by $600b annually, it actually isn’t hard to envision a world where China alone -- through SAFE, the CIC or another vehicle -- buys more US equities than the rest of the world combined (politics permitting, of course). Total (net) foreign portfolio purchases of US equities in 2007 were only about $200b.

Right now SAFE needs to place roughly $2.5b a working day day. 1.6% of TOTAL only cost $2.8b. Do the math ...

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