August 02,2009

CIC Swims Against the Tide

By CT Johnson

China Investment Corp, the country's sovereign wealth fund, is planning to invest $500 million with US private equity firm Blackstone's fund-of-funds division and to place a further, undisclosed sum of money with US investment bank Morgan Stanley's asset-management group.  CIC's move is surprising because it stands in stark contrast to the actions of other sovereign wealth funds, and to those of other Chinese firms making investments abroad.

CIC already holds significant positions in both firms, having spent $10 billion on stakes in Morgan Stanley and Blackstone since 2007.  The relationships have not been without their difficulties.

CIC was badly scarred by its initial investment into Blackstone in 2007 (the fund's first ever deal), which saw $3 billion decline to its present value of $1 billion.  The fall of Blackstone's shares resulted in an avalanche of criticism from rival agencies in the government as well as Chinese citizens at large, many of whom accused CIC management of incompetence and even treason.

These setbacks caused a noticeable cooling in the pace of CIC's international acquisitions.  The fund now appears to be emerging from its self-imposed absence from the M&A stage.

was started in 2007 to help diversify China's foreign exchange holdings, which have historically been heavily invested in US government securities.  The fund has over $200 billion under management, making it one of the world's newest and largest investment funds.  Because of its aggressive stance on outbound investment, the fund is also becoming one of the most important sources of cash for the hedge-fund industry.

CIC has recently gone through an internal reorganization 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 half of CIC's total holdings.

In recent months, the fund has announced deals for a further interest in the US's Morgan Stanley, a stake in Australia's largest property trust, Goodman Group, the shares of Teck, a Canadian mining company, and a 40% interest in CITIC Capital, a Chinese investment firm.

CIC's latest moves differ markedly from those of other sovereign wealth funds, which have been battered by the world-wide financial crisis.  The audacity of CIC is driven partly by the massive growth in China's foreign reserves, which have now reached $2.1 trillion.  With falling confidence in the US dollar and US government treasuries, the government is looking for places to put its money.

Even accounting for the pressure on CIC to usefully deploy a larger portion of China's surplus, the fund's investments philosophy is strikingly different from that of other Chinese firms.

As Daniel Rosen and Thilo Hanemann of the Peterson Institute for International Economics explained in a recent policy paper, except in the area of natural resources, Chinese firms are generally reluctant to undertake overseas investments.  Foreign markets are often viewed as opaque and intimidating; foreign assets are viewed as expensive and hard to manage.  CIC appears to be wholly free of such misgivings, having invested boldly in the US, Australia and Canada.

In part, CIC derives greater confidence from better management.  While only two CIC board members have significant experience outside of China (Gao Xiqing, the fund's Chief Investment Officer, holds a JD from Duke Law School and Zhan Xiaoqiang, a non-executive director, who was an economic counselor at the Chinese Embassy in the US), they are all highly accomplished.  Few Chinese firms, even giants like Aluminum Corp of China or China National Petroleum Company, can boast similar talents. 

CIC has also worked to mitigate the risk of dealing in overseas markets through the action of its newly created International Advisory Council.  The IAC contains such luminaries as Taizo Nishimuro, Chairman of the Tokyo Stock Exchange, and John Thornton, former President of Goldman Sachs, whose job is to help advise the fund on threats and opportunities coming out of overseas markets.

Finally, CIC has employed a curiously effective "hands off" strategy when it comes to management of the companies it invests in.  "[CIC] is not involved in day-to-day issues within the institutions in which it invests," says the company's website.  This approach, originally used to avoid political opposition to CIC investments, neatly side-steps issues related to managing cross-border assets. 

In moving confidently into the international arena, despite criticisms at home and economic turbulence abroad, CIC continues to swim against the tide.  With a variety of emotions, eyes in China and elsewhere are watching closely to see how their intrepid strategy fairs.

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