BEIJING The establishment of a state-controlled investment company to further diversify Chinas $1.33 trillion in foreign-exchange reserve assets might spell opportunities for U.S. alternative managers, according to consultants and other experts.
On Aug. 29, Chinas Ministry of Finance launched a 600 billion yuan ($80 billion) bond sale to finance the tentatively named China Investment Corp., which is scheduled to begin operating within the next several weeks. Another 950 billion yuan worth of government bonds will be issued in two tranches later this year to bring initial assets under management of the fledgling company to about $200 billion.
The majority of the assets will be used to recapitalize several state-owned banks in an overhaul of the banking system. But the CIC will be left with an estimated $70 billion to $80 billion in play money, said Stephen Jen, London-based managing director and chief currency economist at Morgan Stanley.
Thats still quite big, said Mr. Jen, who formerly worked as an economist focusing on Asia and Eastern Europe for the International Monetary Fund in Washington. If they do well and achieve what they set out to do which is to meet if not exceed the return theyre getting now then they will continuously get more money. Most of (the reserve fund) could, in theory, eventually end up there.
Ministry officials havent revealed details of the CICs investment strategy, but several sources following the developments reckoned one main purpose of the CIC will be to invest in alternative assets.
While developed market equities have not been ruled out, consultants believe the CICs portfolio will likely be dominated by emerging market securities, private equity, real estate, hedge funds, infrastructure and other strategic direct investments, with external managers to run at least a portion of the portfolio, consultants said. Experts believe such assets will help meet the governments aim to maximize returns and diversify the reserve fund, while accessing certain holdings that help to sustain Chinas economic boom.
U.S. managers with expertise in alternatives might be in a position to benefit, although any changes will take some time, said Peter Alexander, founder and principal of Z-Ben Advisors Ltd., an investment management consultant based in Shanghai.
Its safe to say that alternatives will be the focus (of the CIC), Mr. Alexander said. But first, they will decide what it is they need to do, what percentage to invest and what is the approach they need to take.
The bond issuance is a way for the government to transfer assets from the foreign-exchange reserve to the CIC without causing significant market disruptions in the global bond market. According to a statement from the Peoples Bank of China, the central bank, the PBC bought the special treasury bonds through an intermediary, the Agricultural Bank of China. The PBC will gradually sell the debt in the open market.
Even before the CIC is officially launched, it has caused a stir. Earlier this year, the Central Huijin Investment Co., another state-owned vehicle, took a $3 billion non-voting stake in New York-based Blackstone Group LP. Central Huijin, which will be folded into the CIC when the latter is officially launched, agreed to hold the stake, estimated at 10% of Blackstones market capitalization, for at least four years.
In this case, (the CIC) moved straight away to the far end of the spectrum, said Andrew Milligan, Edinburgh-based head of global strategy at Standard Life Investments Ltd.
Officials at sovereign funds usually take small steps from relatively safe overseas assets such as U.S. Treasury securities to more mainstream global equity and then, perhaps, moving into hedge funds and commercial property, Mr. Milligan said. They tend to build up expertise and slowly widen the array of assets.
The Blackstone transaction gives us a hint that (CIC officials) are very happy to make quite high-profile investments, strategic investments, rather than timidly moving along the risk curve, he added.
On the heels of the Blackstone transaction, government officials appointed Gao Xiqing, vice chairman of the 282 billion yuan National Council for Social Security Fund, Beijing, to a top position at the CIC. It is not clear what Mr. Xiqings title will be, but given his experience at the NCSSF, he most will likely have a leading role in determining the CICs investment strategy, according to Mr. Alexander and other consultants. Neither Mr. Xiqing nor Jesse Wang, vice chairman of Central Huijin Investment, responded to interview requests by press time.
In 2006, Mr. Xiqing who graduated from Duke University in 1986 with a law degree led an effort by the NCSSF to tap 10 foreign asset managers, primarily from the U.S., to run overseas equity and fixed-income portfolios totaling about $1 billion.
In the years that he has been at the national council, Gao Xiqing started to really actively diversify assets through a very methodical process and hiring (external) managers to invest on the funds behalf, Mr. Alexander said. Not to read too much into the tea leaves, but it wouldnt be a big surprise if he were to take a similar approach at the CIC.
Most sovereign funds look to external fund managers to provide more than just investment performance, according to Garry Hawker, Singapore-based senior investment consultant and head of Asia ex-Japan for Mercer Investment Consulting. Knowledge transfer is an important part of the relationships, he added.
Mr. Milligan of Standard Life added that it will be the heavyweight, global asset managers providing depth of (investment) process and quality of analysis that will most likely benefit from Chinas efforts to diversify.
It may be awhile before theyll take the specialist approach, Mr. Milligan said. So far, it has been big blue-chip names.
The motive behind Chinas efforts to diversify its reserves has been led by a desire to adopt global investment best practices and spurred by the depreciation of the dollar, consultants said. The reserve fund now is mostly invested in U.S., U.K. and eurozone government bonds. An overwhelming majority of the total assets estimated by some banking analysts as high as 75% are in U.S. government bonds and other securities.
Patrick McCoy, partner and head of investment advisory at KPMG LLP in London, believes private equity and infrastructure might prove attractive to CIC officials because both asset classes are gaining acceptance among sovereign fund investors generally. These types of assets also help to build Chinas strategic links to ensure its commodities supply chain is protected.
When youve got a lot of money, youre not looking for small investments. You need to really have big, chunky investments to make it worthwhile, Mr. McCoy said. There are two routes they can take in doing this either build in-house expertise or delegate to a fund manager, which is very possible.
In addition, CIC executives also might consider distressed assets emerging from the recent turmoil in the credit markets, Mr. Milligan added. Exposure may be gained through hedge funds, private equity managers, direct investments or other alternative strategies.
Historically, pension funds and insurance companies with a long-term view have been buyers of distressed assets. But of course, at the moment, pension funds and insurance companies are facing completely different regulations that may prevent them from doing so, Mr. Milligan said, referring to such regulations as a move to mark-to-market accounting rules globally. Who else are the long-term investors at the moment? Its the sovereign wealth funds.