Investing a Nation's Wealth Wisely

Wu Weihai, a researcher at the research institute under the Ministry of Industry and Information Technology, says wealth funds usually base their global investments on two factors. While the first approach focuses on buying equity in companies and industries to gain dividend and stock premium, the other is concentrated on rights purchases in selected companies to gain management control. "It is obvious that the CIC investment strategy falls into the first category," Wu says.

The next step for the CIC should be to invest in overseas industries that have advanced technologies or management capabilities, because it would help accelerate domestic industrial upgrading and facilitate economic rebalancing, Wu says.

"The company's goal is pursuing long-term returns by customizing investment strategies based on different projects in different countries," CIC vice-chairman Gao says. "The investment theme is not for mergers and acquisitions, or to control any overseas company. We don't want to be seen as a destroyer by any country."

According to the company's 2012 annual report, by the end of last year, the company's total assets stood at US$575 billion, compared with US$482 billion a year earlier. About 32 percent of its overseas investment were in public equities, 32.4 percent in long-term investments and 19.l percent in fixed-income securities.

"We have increased purchases of public equities and steadily boosted long-term investment in infrastructure construction, energy and mineral resources, and real estate," the unnamed official says.

Different role

Last year was the fifth anniversary of its establishment and at that time the fund's board of directors reviewed and approved its 2012-16 Strategic Plan of Development, which outlines the guidelines for the CIC's overseas investment. During the meeting, the directors decided to extend the investment horizon to 10 years and adopted rolling annualized returns as an important benchmark to evaluate the performance.

Ding, the current chairman and former deputy secretary-general of the State Council, says the CIC zeroed in on the endowment model of asset allocation after looking at several such models in the past five years.

"We have developed the policy portfolio to better align and balance our strategic and tactical asset allocation, and to improve portfolio integrity, boost fiscal discipline and for prudent management."

In 2011 the company suffered a loss of 4.3 percent on its overseas investment projects, compared with a profit of 11.7 percent in 2010, raising serious doubts over its investment measures and risk control system.

A research note from Zero Power Intelligence Co Ltd, a Chinese market research firm, indicates that the CIC's returns are directly related to the performance of the global financial market. The loss in public equities and direct investment projects was the main reason for the CIC's negative return in 2011, when the MSCI World Index dropped 7.4 percent, the research note said.

The sovereign wealth fund was launched in September 2007 with registered capital of US$200 billion. Of this, US$90 billion was transferred to domestic financial institutions through the CIC's wholly-owned subsidiary Central Huijin Investment Co Ltd, while the balance US$110 billion went for overseas investment.

Liu Shangxi, deputy director of the Research Institute for Fiscal Science under the Ministry of Finance, says that unlike other sovereign wealth funds, the State Council has clearly specified the duties and functions of the CIC. "The main task of the CIC is to manage the foreign exchange given by the central government and use it on behalf of the state to invest in overseas markets," Liu says.

About 49.2 percent of equity purchases have been from the US markets, compared with 27.8 percent in other advanced economies and 23 percent in emerging markets, the CIC annual report said. In addition the CIC has invested 22.3 percent of its fund in the overseas financial sector, while 11.6 percent is in the information technology sector and 10.7 percent in the consumer discretionary industry, it said.

Guo Tianyong, a professor at the Beijing-based Central University of Finance and Economics, says the CIC must maintain "long-term investment" and diversify risks for long-term gains. "The fund should also emphasize on talent retention and cultivation because it would help in sound growth of foreign exchange reserves," Guo says.

Although there have been some reports that the Chinese central bank and the State Administration of Foreign Exchange (SAFE) are planning to create a new institution for using the forex reserves for investments, so far, neither the central bank nor the CIC has given any such indications, experts say.

In January, SAFE launched a special office to invest foreign exchange reserves overseas in terms of entrusted loans. Most of the borrowers of such loans are enterprises that are planning overseas expansion.

"CIC faces competition from SAFE, which is also investing in equities, private equity, real estate and infrastructure to diversify China's foreign exchange reserves," says Barbary of Sovereign Wealth in London.

"Ideally, there wouldn't be two different funds attempting to fulfill the same role and an ongoing funding stream would be designated to the single fund. In that way, China might develop a fund like the Government of Singapore Investment Corp. However, given the circumstances, an endowment model is a good option for the CIC," she says.

By the end of 2012, China's total foreign exchange reserves reached US$3.31 trillion. About 60 to 70 percent are dollar assets. According to the US Treasury Department, China's holdings of US Treasury bonds increased by US$25.2 billion in May and the total reached a record high of US$1.315 trillion. It rose by US$151.9 billion from a year earlier.

Xu Hongcai, a senior financial researcher at the China Center for International Economic Exchange, a government think tank, feel that it is imperative for the CIC to diversify its investments in US Treasury bonds.

"A better choice is to invest in overseas infrastructure projects and support overseas moves of Chinese enterprises," he says.