China's Sovereign Wealth Fund Favors Real Economy

From Market, page 16, issue no. 408, March 2, 2009
Translated by Tang Tang
Original article: [Chinese]

China's sovereign wealth fund, China Investment Corporation (CIC), has distanced itself from the toxic financial assets abroad. Instead, it is now exploring new investment fields, such as the real estate and resource industries.

CIC recently published a recruitment advertisement on its website looking for professionals in real estate and other alternative investments, such as private equity.

Industry sources told the Economic Observer that CIC was pooling talent and paving the way for a new phase of investment strategy. "Judging from the current economic climate, it would be safer to invest in the assets backed by the real economy activities," said a source.

Another source close to the matter said CIC had been considering a change in investment direction to better guard state resources.

Last year, the 200-billion-US-dollars-strong sovereign wealth fund was burned by investments in foreign financial institutions Blackstone and Morgan Stanley, both of which were hit by the financial crisis and saw share prices plunge.

The Need to Look Elsewhere
The return on investment for the CIC has long been an interest for both domestic and foreign market observers. Foreign media recently reported that CIC had posted a 5% annual investment returns and pocketed 10 billion US dollars in profits, thanks to its timely withdrawal from further investments abroad; however, CIC declined to comment on the reports.

The funds under CIC guardianship were raised through bonds issuance, with an annual interest of 5%. To service the interest alone, the company would need to earn at least 300 million yuan in daily income, which could only be realized with an investment return of over 10%.

CIC president Gao Xiqing had once said the company was under tremendous pressure to perform, as never in the history of the country's foreign reserves investment recorded such a high rate of return.

Soon after CIC was established in September 2007, it paid 67 billion US dollars to acquire Central Huijin from China's State Administration of Foreign Exchange (SAFE). At that time, Central Huijin held equities worth some 350 billion US dollars in state-owned banks like the Industrial and Commerce Bank of China (ICBC), China Construction Bank (CCB), and Bank of China (BOC).

A source with insight into CIC operations said earnings from the above banks would have offset the losses CIC suffered from the investments in Blackstone and Morgan Stanley. But if taking into consideration the 66 billion yuan of principal interest that CIC needed to pay yearly, its returns could have landed it in the red.

However, the annual financial statement usually would not include payments for capital interest, which would only be of interest to the company in costing.

Though CIC had adjusted its investment strategies along the way, losses continued to mount due to its earlier purchases of foreign financial institutions. CIC chairman Lou Jiwei had late last year told the media in Hong Kong that "The market is too volatile nowadays, we lack the courage to risk investing further in financial institutions".

New Favorites
The current economic turbulence, however, had also opened doors for new ventures, said a source close to CIC.

The source said prices of natural resources had been plummeting in the global market, but when the economy recovered, prices of these resources would definitely rebound sharply. He concluded that this would be the best time for CIC to venture into foreign resources.

Indeed, amidst the recent spate of Chinese companies rushing to buy overseas resources, CIC too had shown keen interest. For example: prior to the recent acquisition of Australia-based Fortescue Metals Group (FMG) by China's Hunan provincial government-owned Valin Iron and Steel Group, the EO learned that CIC chairman Lou Jiwei had held meetings with senior management of several foreign mining companies, including FMG.

CIC, as a sovereign wealth fund, faced several challenges in acquiring foreign resources - namely how to avoid drawing the suspicion of other countries, and circumventing various barriers to investing in the target.

One industry expert who requested anonymity said there were several ways to remain low-key while accomplishing deals. One was by funding local Chinese firms to venture abroad, and the other was to use its second or third-tier subsidiaries to carry out foreign acquisition.

“This is a window of opportunity for Chinese firms to undertake M&A (merger and acquisition) abroad, and it's a window that will not be open forever,” said Zhang Ming, a researcher of International Economics and Politics Institute under the Chinese Academy of Social Sciences.

A market observer said CIC usually entrusted seasoned foreign fund managers or international investment banks to carry out foreign acquisitions, and that this strategy might be a double-edged sword.