Amid growing politicized hostility to state investment, Lou Jiwei, head of China’s sovereign fund, earlier this year offered the clearest insight yet into the agency’s strategy and aims
Sovereign wealth funds are large – and growing fast. On today’s estimates, they hold roughly 2% of tradable assets in the world, managing between $2 and $3 trillion between them.
But their growing influence and highly guarded nature have been accompanied by mounting suspicion of their motives, especially in the US and Europe, where officials are increasingly demanding more transparency and disclosure. High-profile investments – at least $59 billion in banks savaged by losses and write-downs on mortgage-related securities – have turned up the heat on the debate.
Amid the politicized hostility to secretive state investors, calls for scrutiny have scarcely been as great as for China Investment Corp (CIC), the country’s $200 billion sovereign wealth fund (SWF).
CIC’s chairman Lou Jiwei spoke in Washington earlier this year, in an unscheduled discussion of CIC at the end of a meeting attended by Emerging Markets. He gave the clearest insight yet into CIC’s approach to investment, addressing many topics of keen concern to western policy-makers and financial specialists – notably the widespread reluctance in the West to accept investment by sovereign wealth funds from emerging markets.
Lou fired a shot across state bows, especially in Europe, that are suspicious of SWFs. “If we find ourselves unwelcome or if we find people have misgivings about our investment, first we will try to make ourselves understood,” he said, “and second, if even after we do that we still feel unwelcome in our investment destinations, we may choose to leave.”
China Investment Corp was set up last year, and little is known about it except that in June it bought a stake of just under 10% in Blackstone Group, the US private equity fund, for $3 billion, and in December took a 9.9% stake in Morgan Stanley. Chinese premier Wen Jiabao has made it clear that two-thirds of CIC’s investment would be in China. The fund has taken over the Central Hujin Investment Corp, a vehicle through which the People’s Bank of China (PBOC) held large stakes in Chinese banks.
On December 31, Central Hujin announced it would inject $20 billion of capital into China Development Bank, one of the country’s big four banks, to aid its transition to a commercial bank and possible flotation. “The purpose of our operation,” Lou said, “is to reduce outstanding issues in [domestic] commercial banking reform.
“Although some of our banks have been reformed, assets remained on PBOC’s balance sheet. With the creation of CIC we bought assets from the PBOC, and they have now become government holdings.”
Freedom to hunt
But while taking over assets from the PBOC was clearly a central part of the original reason for setting up the CIC, Lou gave the impression that the fund would have considerable freedom in how it invested money overseas, and certainly that it had no preconceived ideas about where the best opportunities would arise.
CIC changed its allocation last month after the government revised the amount needed to restructure some struggling state-owned financial institutions. The fund now has $90 billion to spend on foreign assets – an increase of more than 30%.
But Lou downplayed speculation that the fund would come to the rescue of other stricken US banks, following its investment in Morgan Stanley in December. He said that CIC’s $5.7 billion investment in Morgan Stanley had been opportunistic and not part of a calculated strategy to invest in the US financial sector.
Stressing the deal did not mean there would necessarily be more money for troubled financial institutions, Lou said: “We don’t want to put all our eggs in one basket, so we will keep our eyes open for other opportunities in other countries and sectors and regions. To me, the deal with Morgan Stanley was a window of opportunity. We should focus more on investment in other industries and other regions.”
Lou said he did not know whether CIC would find similar opportunities in the financial sector. But he hinted that CIC had considered other financial institutions before investing in Morgan Stanley. “Before our deal with Morgan Stanley, we had discussions with a number of institutions,” Lou said. “Among them, Morgan Stanley was in the best shape. It may not be the fattest rabbit. However, its condition was the best.”
Lou likened CIC’s investment approach to farming: sowing seeds and cultivating the land. But, referring to opportunistic deals, he said that: “If there is a big fat rabbit we will shoot it. I will continue to be a farmer. However, I will keep a rifle at hand.” Lou said he had not seen any other fat rabbits yet.
He made it clear that Morgan Stanley had approached the CIC, but that after careful analysis the fund had realized this was a good opportunity, and so made the investment. But in reference to deepening turmoil in the financial sector, Lou quipped that nevertheless: “Some will say we were shot by Morgan Stanley.”
CIC’s investments have come under fire domestically for their lacklustre performance. Its $3 billion investment in Blackstone last May has lost almost half its value so far. But the sovereign fund has since signed a deal with New York-based private equity firm JC Flowers & Co (JCF) to launch a $4 billion fund, to focus investment on the US financial assets of banks distressed by the snowballing credit crisis. CIC will reportedly put $3.2 billion into the $4 billion fund as the limited partner.
Beyond profits
Turning to CIC’s philosophy of investment, Lou dismissed suggestions that CIC cared only for its own profitability. “We will not be 100% profit driven. We will also fulfil our corporate social responsibility,” he said. “That’s why we’ve been very interested in products related to the natural environment and cleaner energy. Although I smoke myself, we will not invest in the tobacco industry. We want to maintain a good public image for CIC.”
Lou added: “Actually, I don’t need to generate such high returns. Five percent is the cost of funding, and our long-term target is a little bit higher than that. So I need to generate enough to cover our cost of funding.” He drew a contrast between CIC and other SWFs, “which have a different capital source” and whose “cost of capital is lower”.
The CIC has been financed by $200 billion equivalent of renminbi bonds issued by the ministry of finance, mainly to Agricultural Bank of China (ABC) but also partly to the market. The ABC bonds were then sold to the PBOC, which is not allowed to fund the ministry of finance directly.
This enables the CIC to soak up some of the PBOC’s huge excess liquidity – a key purpose of CIC.
Lou said that CIC would ultimately resemble Singapore’s Government Investment Corp (GIC), which is regarded as one of the most secretive of the leading sovereign wealth funds. It has more than $100 billion of assets and recently invested Sfr11 billion in UBS and $6.8 billion in Citi.
“People’s apprehensions are mainly about whether we operate on particular motives or not,” he said, alluding to fears that SWFs might serve the interests of their political masters, to the potential detriment of the host countries of their investments. Emphasizing that the fund pays 5% interest on its capital, to cover the interest on the government bonds, he said: “I need to make money. If I don’t, I can’t survive. How can I have political motives?”
Taking a back seat
Lou even emphasized that CIC did not want to be an activist investor. “We voluntarily gave up voting power [in Morgan Stanley and Blackstone], and our investments are less than 10%,” he said. “I don’t want to make trouble for anyone or myself.” Referring to Morgan Stanley, he said: “I think John Mack can do a better job than we can, so why not just let him do the job?”
Lou responded to western observers who have been taken aback by the sheer size of CIC. “Ideally, I would have liked to start with $2 billion, grow gradually to $20 billion and then in five years grow to $200 billion,” Lou said. “Getting so much at the beginning is not because we are ambitious. It was because of China’s macro policy needs.”
He also made a case for CIC as a benign force in international markets. “We can play the role of a stabilizing force in financial markets, and our investments can bring jobs and stability, like other sovereign wealth funds,” he said.