CIC Takes Pivotal and Expanding Role in Managing Chinese State's Investments at Home and Abroad

In publishing its annual 2008 report last week, the China Investment Corporation (CIC) stated that it achieved an overall 6.8% return on capital, largely down to the growth in its sizeable and expanded equity stakes with the state-owned Chinese banks through its Central Huijin Investment arm. Many Western banks divested their previous equity stakes in Chinese banks over 2008, in order to help repair their own battered balance sheets, while CIC took larger equity shares to help support the stock market. China's stock market is up by some 65% so far over 2009. The report went on to show that CIC's global portfolio return was -2.1% in 2008, but added that this was better than other sovereign wealth funds (SWFs), university endowments, and pension funds. On average, global equity indexes fell by 45% over 2008 and non-AAA sovereign bond indexes fell by an average of 18% over 2008. In part, the relative good CIC performance was down to the fact that much of the original US$200 billion fund remained uninvested and left as cash.

Earlier Investment Mistakes Have Served CIC Well

The 2008 annual report indicated that an unusually high 87.4% of the entire fund remains as cash. The very high cash composition of the fund may in part be down to the fact that the CIC fund had yet to set up investment networks and formulate strategy since its fairly recent inception in December 2007, and partly because its very early high-profile US$3-billion investment with U.S. private equity group Blackstone and US$5.6-billion equity stake with U.S. investment bank Morgan Stanley quickly turned sour with mark-to-market losses during the course of the deepening credit crunch and falling markets over 2008. The popular backlash at home extending into political circles is a domestic reputational risk that SWFs uniquely face, quite apart from how they are viewed in Western host countries. These reputational risks effectively kept the CIC fund quiet over much of 2008 with overseas forays. Only after Western governments propped up their ailing banking systems and extensively reliquefied the financial system aggressively over the last eight months, to see, eventually, some emerging stability in financial markets since March 2009, did CIC embark on a more aggressive foreign expansion (see table below).

Chinese External-, Current-, and Capital-Account Surpluses Continue to Fund Foreign Asset Expansion

The credit crunch and recession in the West, as well as many emerging markets (EMs), have begun to alter the size and global pattern of so-called "global imbalances", that is, the current-account surpluses and deficits generated around the world. Although the largest imbalance of them all, the U.S. current-account deficit, has clearly narrowed as U.S. domestic demand has weakened, it has not altogether disappeared, falling by around one-half since its peak in 2006 (see "Global Imbalances" chart below). Export surpluses earlier generated by many energy exporters have in many cases virtually disappeared, particularly if falling oil prices and oil demand from one year ago are reinforced by strong counter-cyclical fiscal stimulus that has drawn in new imports, as in the case of the major Middle Eastern oil exporters, Russia, Kazakhstan, and Mexico. The significance for global capital flows is the likely lower foreign asset build of these energy exporters that have also been a major new source of financial investment into EM assets, as domestic growth and investment concerns remain paramount. Where energy exporter current-account surpluses have largely evaporated, the fuel behind capital outflows and their associated foreign asset build has also weakened. The two areas of exception here are first among energy exporters that have proportionately larger "super surpluses", like Norway, Qatar, Kuwait, and Libya. Secondly, those countries that have retained their export better than others are China and Emerging Asia, where despite the fall in exports of 20-25% as international trade collapsed over the past 12 months, surpluses have been retained from a favourable shift in terms of trade that has lowered the unit value of these countries' predominantly commodity-based imports. The retention of export surpluses in China and other EM Asia countries, has fuelled a new "resource rush" (see Sovereign Wealth Fund Tracker—Q1 2009) since the start of 2009. China remains by far the largest capital exporter or foreign asset accumulator in the world, despite the "Great Global Recession", and the changing pattern and strategy behind its foreign asset build will continue to have a profound effect on a wider range of asset markets, from oil and commodities, to U.S. long-term bond yields and developments in the financial markets, including the hedge fund and private equity sectors where CIC is prominent among Chinese state investors.

CIC Expanding and Diversifying its Global Portfolio

CIC has made several new foreign investments since March 2009 (see table above). It is believed to have invested an additional US$500 million with U.S. private equity firm Blackstone's "fund-of-funds" division, to add to its original US$3-billion equity stake taken in late 2007. CIC is also to place a further, undisclosed sum of money with U.S. investment bank Morgan Stanley's asset management group, following its original US$5.6-billion equity investment made at end-2007, and following its more recent US$800-million investment in the U.S. firm's "Global IV" property fund in February 2009. CIC already holds significant US$10-billion investment positions in both U.S. financial firms, but unlike other Chinese state investment funds and other non-Chinese SWFs, new investment in U.S. financial firms has been rare over the last 12 months. CIC's first controversial US$3-billion investment in Blackstone in 2007 saw its value drop to just US$1 billion, resulting in much criticism at home.

The initial Blackstone setback slowed the pace of CIC's international acquisitions over 2008 and partly explains the outsized 87% cash holding of the fund that has served it well, while most risk assets fell in value during the course of 2008, but CIC appears to be back on the merger and acquisition (M&A) expansion path in 2009. Chinese state entities are encouraged by their higher sovereign owners to venture abroad for acquisitions, although this has mainly focused on the "real sector" and resources in particular since the start of 2009. CIC has been different from other Chinese entities with bolder foreign investments in a broader range of sectors, including the credit-crunch-ravaged financial sector. All these foreign asset acquisitions can be seen as part of diversifying China's huge US$1.2-trillion foreign-exchange reserves, the CIC's original purpose when it was set up in late 2007. Because of its aggressive stance on outbound investment, the CIC fund is also becoming one of the most important sources of cash for the hedge fund industry. CIC has recently gone through an internal reorganisation and changed its investment strategy, eschewing its previous focus on the financial sector for a broader strategy encompassing the "real economy". Currently, financial investments account for more than one-half of CIC's total holdings. In recent months, apart from its Blackstone and Morgan Stanley investments, the fund has announced deals with Australia's largest property trust, Goodman Group, a 17% equity stake in Teck Resources, a Canadian mining company, and a 40% interest in CITIC Capital, a Chinese private equity investment firm. Over the last few months CIC took a 1.1% (US$360 million) stake in U.K.-based international drinks retailer Diageo and is believed to have increased its exposure in the Indian stock market by around US$150-200 million through index funds. Diageo itself has been buying a significant stake in the Indian Vijay Mallya-owned United Spirits. Other Chinese entities have been generally reluctant to make investments outside of the natural resource sector.

Foreign markets are often viewed by the Chinese as awkward and opaque, and suspicion remains in Western political circles, although the impact of the credit crunch has made Chinese investment much more accommodating than 18 months ago. Furthermore, foreign equity stakes are viewed as difficult to manage and acquisitions have sometimes fallen through. CIC appears much more confident, however, having invested boldly in the United States, Australia, and Canada. In part, CIC derives greater confidence from better management and its longer standing connections with other Western and Asian financial firms. To add to its international investment skills, CIC has recently announced the names of the 14-member Advisory Council. The council will meet once a year to advise on strategic issues to investment for the US$200-billion SWF. CIC has listed the members as: Zeng Peiyan, former vice-premier of China; Lawrence Lau, vice-chancellor of the Chinese University of Hong Kong; Frederick Ma, former Hong Kong secretary of commerce and economic development; Taizo Nishimuro, chairman of the Tokyo Stock Exchange; Yingyi Qian, dean of the School of Economics and Management at Beijing's Tsinghua University; Andrew Sheng, former chairman of the Hong Kong Securities and Futures Commission; David Emerson, former Canadian foreign minister; Arminio Fraga, former Brazilian central bank governor; Merit Janow, Columbia University professor of economic law and chairman of NASDAQ; John Thornton, former president of Goldman Sachs; James Wolfensohn, former World Bank president; Knut Kjaer, president of RiskMetrics Group and former CEO of Norges Bank Investment Management; Jean Lemierre, former president of the European Bank for Reconstruction and Development; and Nicholas Stern, former World Bank chief economist and author of a landmark report for the British government on climate change.

Outlook and Implications

CIC is setting itself apart as the pivotal and most sophisticated global asset investor on behalf of the Chinese state. If the recent annual report figures are to be believed, CIC's financial performance over 2008 has been relatively good on a relative basis, considering most other SWFs, Pension Funds, and commercial investment funds performed far worse. Apart from a few Middle Eastern funds, namely Aabar of Abu Dhabi and the Qatar and Libyan investment Authorities, CIC has been the boldest and most active SWF over 2009, making extensive forays in a broad range of asset classes and sectors. More deals and investments are likely to follow as China continues to accumulate foreign-exchange reserves and aims to diversify the broader Chinese sovereign asset portfolio. The CIC fund is developing its links and investments with the hedge fund and private equity sectors, both in the United States, the United Kingdom, and Asia, and is likely to gradually internalise the best of Western financial acumen, and avoiding the worst, as part of its long-term strategy to "transfer technology" from these knowledge-based sectors, as it has already done for many parts of industrial manufacturing. In short, CIC is emerging as one of the key new global financial power brokers in the fast evolving global financial landscape, during and after the credit crunch and "Great Global Recession".

Global Insight (Reino Unido)