Talking Point

Fast learner

Its early investments lost money, but CIC has revived its performance

With so much money to invest, CIC's Gao Xiqing can afford a smile

“Be nice to countries that lend you money” was Gao Xiqing’s suggestion, in an interview in The Atlantic magazine late last year.

Gao, a former Wall Street lawyer and Hong Kong investment banker, serves as the de facto number two at China’s two-year-old sovereign wealth fund, China Investment Corporation (CIC).

His advice was meant affably enough. Presumably it extends to countries that want to invest in you as well. And with speculation this month that CIC could receive a $200 billion top up on the initial $200 billion of financing first made available in late 2007, Gao must be hoping for a series of rather pleasant conversations.

In fact, CIC has endured a difficult couple of years. Ducking foreign brickbats as the unacceptable face of global capitalism, then dodging domestic accusations of overpaying for foreign assets, the new team has had a tough baptism.

But the news flow on a stream of recent investments suggests that the fund is finally finding its feet.

Why was CIC created?

Two reasons: Beijing’s burgeoning pool of foreign exchange reserves, and the perception that those reserves ought to be generating a better income. Analysts estimate the reserves generated returns of between 2% and 4% in the period 2003 to 2006 (at a time in which the domestic economy was growing at around 10% a year). Mix in the growing sense of the vulnerability of the US dollar (by far the largest currency that China holds), and the pressure for investment on a more diversified basis began to tell.

Not that everyone thought CIC should be the agency in charge. The reserves custodian (the State Administration of Foreign Exchange or SAFE) seems to have had particular doubts, and it has continued investing sovereign wealth itself (in stakes in Australian banks, France’s Total, and BP) long after CIC opened for business.

That turf war rumbles on. But the speculation is that SAFE has invested far more aggressively than it has admitted publically, switching up to 15% of reserves into equities only shortly before global stock markets went into their death-defying dive last year. That may have blown a hole in its ambitions for a leadership position, clearing the way for CIC to take on the role itself.

So CIC has done better?

Not initially. Two high profile investments in late 2007 in private equity firm Blackstone ($3 billion) and investment bank Morgan Stanley ($5.6 billion) lost much of their value too, although both have since made up some of the lost ground. CIC was on the receiving end of some intense local criticism– particularly for buying into the Blackstone IPO.

The results for the 2008 financial year made for better reading, with assets under management growing to $298 billion. CIC fared well in comparison to its global peers (reporting a loss on overseas investments of 2.1%), primarily by bulking up in cash in the uncertain times.

The snipers argue that this was more a case of luck than judgement; CIC was so new that it didn’t have the people to go out and make more investments. But this year the spending trend has picked up rapidly. Some months have seen more invested than in the entirety of 2008.

There has also been a switch away from investments in financial services and more towards commodities. Kazakh oil-and-gas group KazMunaiGas, Canadian miner Teck Resources and global commodity trader Noble Group have all taken CIC money this year. Deals have been completed with Mongolian miner SouthGobi and Indonesian coal producer Bumi Resources too.

Last week CIC seemed to switch tack again, this time with a $710 million investment in GCL Poly, China’s largest producer of polysilicon. Silicon is an ingredient in solar panels – an industry in which China thinks it has a technology advantage that could see it leapfrog competitors.

But CIC is regarded with some suspicion overseas?

The fear is that it has an eye on a shadowy geopolitical agenda – and not just on financial returns.

Opponents fret about proprietary technology or research being lost to the CIC shareholder or that Chinese domestic champions will get an unfair leg-up on international competitors.

But CIC has already made clear that it will not consider investments that trigger CFIUS (Committee on Foreign Investment in the United States) security reviews.

CIC boss, Lou Jiwei, argues further that a “big portion” of CIC money (a number that varies from $30 billion to $80 billion depending on your source) is in the process of being invested in third-party asset managers like hedge funds – with US distressed debt a favoured theme.

So although CIC will monitor the performance of these investments closely, it has contracted out of most of the operational decision-making.

Building a portfolio of stakes looks like a sensible move. But there are still those who see darker motives, and a CIC attempt to slip past the security watchdogs.

Perhaps it is a problem of communication?

By commercial design, institutions making multi-billion dollar investments are cautious about throwing open their doors to public scrutiny. The campaigner Transparency International reports that less than a fifth of sovereign wealth funds worldwide are audited by their own national legislatures. Only Norway and Alaska release audited statements to the general public.

CIC also may well wonder if it is being held to a higher standard than counterparts elsewhere.

Take a 60 Minutes interview last year, when CBS reporter Lesley Stahl took Gao to task on CIC’s secrecy. Why can’t you be like Norway, Stahl berated, and why aren’t you issuing annual reports telling the world what you are doing?

But CIC says its mandate is limited to financial returns.

“Our investment must make money,” Lou has stressed, “I don’t care how many tonnes of oil we can ship home. What I do care about is the stock price.”

He has argued too that he needs to make $40 million a day just to cover his obligations (CIC funds were originally underwritten with bonds paying a 4.5% coupon). The inference is that this was a structure styled to keep CIC feet to the fire in investment terms. There was no wriggle room for longer-term “strategic” investments.

More recently, the Economic Observer has speculated that this stipulation has been relaxed. Even so, most commentators agree that there has been an attempt to cut CIC from a new bureaucratic cloth. The fund is staffed by technocrats and not by career politicians. It reports directly to the State Council (in an attempt to lift it above the inter-ministry rivalries) and its employees have foreign educations, experience working abroad and even overseas citizenship. This all looks like an attempt to build an agency that can operate above the old school intrigue.

But there is a caveat?

Much of CIC’s money has actually been invested at home. That’s why it was able to report a 6.8% return on capital for 2008 – with cashflow from stakes in a range of domestic state-owned banks like Bank of China (BOC), China Construction Bank (CCB) and the Industrial and Commercial Bank of China (ICBC).

But the overseas investments will probably serve as the true testing ground for CIC ambitions.

Not that Gao is short on deal-making confidence. In an anecdote from the height of the credit crisis, Too Big To Fail author Andrew Ross Sorkin reports how Morgan Stanley boss John Mack was stunned by Gao’s bold offer to loan him $50 billion in emergency funds. The deal was contingent on CIC buying 49% of the US firm’s equity for $5 billion.

Of course, Morgan Stanley managed to survive without a CIC bailout. But with a replenished war chest – and the mandate to go out and spend it – Gao will be hoping to drive a series of hard bargains elsewhere.


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