China Investment Corp. — one of the fastest-growing funds in the world — is likely to outsource tens of billions of dollars within the next few years to money managers specializing in alternative and emerging markets strategies, according to sources familiar with the $332 billion sovereign wealth fund.
Indeed, what began in piecemeal around 18 months ago is likely to accelerate in the coming months if market conditions are favorable, sources said.
On top of the available cash assets totaling about $25 billion, The CIC is expected to receive an additional $100 billion transferred from China's $2.45 trillion currency reserve in the coming year, according to Michael McCormack, executive director of Shanghai-based consultant Z-Ben Advisors Ltd. The CIC likely will retain at least 10% of the portfolio in cash; the remainder is expected to be deployed to new investments.
“Ideally, (the CIC) would want managers with a track record of putting money to work who can take an extra billion without distorting the portfolio,” Mr. McCormack said.
In 2009, fund officials had invested about $58 billion, most notably through a series of high-profile direct investments in natural resources, infrastructure and financial sectors. In comparison, only about $21 billion had been invested in the 15 months between the launch of the fund in September 2007 through year-end 2008, according to the CIC's annual report published in July. (The remainder of the CIC's assets is largely used to capitalize some of China's top financial institutions.)
The next phase of portfolio construction is likely to focus on diversification in favor of emerging markets and alternative strategies, according to sources who asked not to be identified because they work with the CIC. One of the top priorities will be to expand alternatives, which comprise about 6% of the CIC's investment portfolio but could climb to 20% or more in the next five to 10 years, according to several consultants and managers who asked not to be identified.
“This is part of a broader trend in which institutional investors, including other sovereign wealth funds, are moving into alternatives generally,” one manager said. “What sets the CIC apart is obviously its size.”
Any one percentage point increase translates to tens of billions of dollars because of the size of the fund, and that will make deploying capital difficult, managers added. “It will be a struggle to build (an alternative portfolio) of that scale,” according to another manager.
To expand the alternatives strategies, it is likely that CIC officials will add to the externally managed as well as internal alternatives capabilities, sources said. Earlier this year, the CIC announced a recruitment drive to hire 64 investment professionals to boost capabilities in such areas as strategic investments, private equity and risk management, sources said.
Everybody (in alternatives) is trying to have a relationship with the CIC right now,” according to one U.S.-based consultant who works with the fund and asked not to be named.
Fund officials are unlikely to set rigid targets for each alternative asset class in order to obtain maximum flexibility, sources said. Real estate investments will be a key element, possibly increasing to as much as 14% from about 4% of the international diversified portfolio.
They are negotiating to purchase large stakes in existing funds, including those now held by Harvard University's $26 billion endowment, sources said. The CIC has committed billions in funds that target distressed debt or undervalued real estate assets run by Goldman Sachs Asset Management, Morgan Stanley (MS) Investment Management, Brookfield Investment Management Inc. and Cornerstone Real Estate Advisers. Officials are also likely to consider investing in North American and European real estate investment trusts, Z-Ben's Mr. McCormack said.
Other alternatives — including private equity and hedge funds — could grow by about four percentage points to 6% combined, sources said.
The CIC's tactical investment department, one of four investment divisions within the fund, currently oversees a directional and non-directional absolute-return portfolio using external managers. The same department also internally manages alternative strategies, including a hedged global equity portfolio and a multiasset strategy, according to the fund's recent annual report.
The CIC's hedge fund portfolio kicked off in 2009 with the appointments of Oaktree Capital Management (OAK) LP (OAK) to run a $1 billion mandate and Capula Investment Management, which is partly owned by GSAM's Petershill Fund Offshore LP, to manage a $500 million portfolio. Separately, hedge fund-of-funds mandates totaling $700 million were awarded to BlackRock (BLK) Inc. (BLK) and MSIM. During the same year, CIC also named Bill Lu, former portfolio manager at Tudor Investment Corp., as managing director responsible for developing the fund's hedge fund and other absolute-return strategies.
Officials at GSAM, MSIM, BlackRock, Oaktree and Brookfield declined to comment. Cornerstone spokesman Graham Bond did not return calls by press time. Efforts to reach Gao Xiqing, president and CIO of the CIC, were unsuccessful.
“What the CIC has in mind for alternatives is to help dampen volatility (in the rest of the investment portfolio). In the early part of portfolio construction, the fund has a big pile of cash, which is the best volatility dampening tool there is, so alternatives is less important,” Mr. McCormack said. “I would expect that going forward, the depth and range (of the alternative portfolio) will improve considerably as (the cash portfolio) shrinks.”
Emerging markets, which already play a prominent role within the CIC's overseas investment portfolio, will expand to include more emerging market debt, sources said.
Access to emerging markets will also be gained through investments in developed-markets companies. For example, the CIC invested $1.59 billion earlier this year in AES Corp., a power company based in Arlington, Va. AES generates two-thirds of its revenue from outside the U.S., with a growing presence in emerging markets.
Gerry Ng, Hong-Kong-based managing director and head of sales, client service and business development for Asia ex-Japan at Baring Asset Management, declined to comment on any specific fund. However, he said SWFs are broadly trying to find “improved yields in choppy markets” by trying to find opportunities wherever they may be, whether in emerging markets or developed markets, direct or indirect investments.