China Investment Corporation in context

From Institutional Investor:

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CIC Emerges
China’s new fund sets high bar on foreign mandates

18 Feb 2008
Kevin Hamlin

For China Investment Corp., which made quite a splash with high-profile investments in Blackstone Group and Morgan Stanley, is getting down to more-basic business. Set up last March to manage some $200 billion of the country’s reserves, CIC in December put out for bid its first four international equity mandates for foreign fund managers. And in a sign that the agency wants to move quickly to build up its overseas exposure, it requested bids late last month for two international fixed-income mandates.

The terms of the equity mandates, the sizes of which were not disclosed, indicate that CIC will be an aggressive investor seeking 10 percent-plus annual returns, say experts.

Three of the four mandates feature an emerging-markets component. Two will be benchmarked against the MSCI emerging markets index and the MSCI Europe, Australasia and Far East index and call for managers to outperform those indexes by 300 and 200 basis points, respectively. A third mandate, for an Asia ex-Japan equities, invites fund managers to propose benchmarks and performance targets. The final mandate calls for managers to outperform the MSCI all-country index by 300 basis points.

“These are very, very aggressive mandates when compared to what the National Council for Social Security Fund did last year,” says Peter Alexander, founder of Shanghai-based consulting firm Z-Ben Advisors. The Social Security Fund, a strategic pension reserve, awarded ten mandates in November 2006 totaling about $1 billion, including six equity mandates focused mainly on developed markets.

CIC has not revealed how much money it will farm out. Fund managers anticipate up to $7 billion in equity mandates this year with $1 billion to $3 billion in the first batch. Applications closed on January 15, and CIC is likely to interview 70 to 80 of an estimated 200 applicants before awarding the mandates as early as March, Alexander says.

On the fixed-income side, CIC is seeking tenders for two mandates: an active global fixed-income portfolio with a target return of 150 basis points over a composite of Lehman Brothers’ U.S., Euro zone, Japan and U.K. Treasury indices, and an active emerging-markets debt portfolio with a target return of 200 basis points over JPMorgan’s EMBI global index. Applications are due by February 29.

Why is CIC being so aggressive? It is paying 4.45 percent annually for the funds it received from the People’s Bank of China, and it also must contend with yuan appreciation. At a conference in December, CIC general manager Gao Xiqing said, “The returns on our national foreign currency reserves have never reached this [4.45 percent] level before. I’m not sure I can do much better than that. We feel big pressure.”

Yet Gao must do much better if he is to enhance returns. Many economists expect the yuan to appreciate by some 5 percent this year and an additional 4 percent in 2009. Alexander says the CIC must target an annual investment return of 10 percent over the long run.

CIC’s $5 billion investment in Morgan Stanley in December underscored its high tolerance for risk and long investment horizon. “With the U.S. dollar weak and the yuan moving up, CIC sees a golden time to buy a good long-term asset fairly cheaply,” says Hong Kong–based Stuart Leckie, founder of pension fund consulting firm Stirling Finance, which advises the Chinese government.

In November, CIC chairman Lou Jiwei said his fund would not be ready to make large overseas investments for at least one year. But the subprime crisis has produced hard-to-resist valuations in some Western financial services firms. “They are unwilling to pass up such investment opportunities,” says Donald Straszheim, vice chairman of Los Angeles–based Roth Capital Partners. “We expect more to be announced near term.”

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