On the prowl

China's sovereign-wealth fund is back on the acquisition trail

Having kept a relatively low profile after big paper losses on its early overseas investments, China's fledgling sovereign wealth fund, China Investment Corporation (CIC), is hunting for acquisition targets once more. Such a move, combined with the more aggressive expansion plans of other Chinese companies, will reinforce speculation that China aims to exploit the global economic crisis by securing strategic assets at fire-sale prices. In truth, the CIC's agenda is more about seeking solid investment returns while helping the government to diversify China's foreign-exchange reserves. Still, Chinese outward investment will remain controversial.

Comments by the CIC's chairman, Lou Jiwei, in mid-April underlined the firm's renewed appetite for foreign investment. Mr Lou talked in particular of the CIC's interest in cautious expansion into Europe. Most importantly, he said that the economic crisis had changed the investment climate. Not only does the collapse in asset prices mean there are bargains for investors like the CIC, but many potential target firms' desperate need for cash is likely to clear away some objections to Chinese investment (particularly when non-controlling stakes in companies are involved).

This is a marked departure from the CIC's hesitant behaviour in the past half-year, when it avoided high-profile foreign investments. That stance was a response to the intensification of the global financial crisis in September and October last year, which hit the value of the CIC's portfolio. A key part of the fund's mandate is to make reasonable returns on its holdings of China's foreign reserves. But the company has been burned by the financial meltdown--in particular by unsuccessful investments in US financial companies.

Curbed appetite

So what has the CIC been up to? During its apparent hibernation, when many overseas markets were too turbulent to invest in, the CIC concentrated on internal restructuring and on domestic investments. As foreign financial institutions sold stakes in China's largest state-owned commercial banks, the CIC stepped in. The fund began purchasing sizeable quantities of shares in domestic banks from September 2008 and continued to do so into January 2009. According to the state-run China Daily newspaper, the CIC now holds shares worth US$22.5bn in China Construction Bank, US$22bn in the Bank of China, and US$22bn in Industrial and Commercial Bank of China.

The recent shift in focus for the CIC, which was established less than two years ago with around US$200bn in capital from China's foreign reserves, underlines the fact that global financials are now unappetisingly risky. Yet Mr Lou's recent remarks on investing in Europe do not necessarily herald the start of an unrestrained shopping spree. Indeed, the need for large overseas investments is becoming less urgent. The downturn in exports has diminished the importance of rebalancing the country's capital flows--a purpose that the CIC's outward investments indirectly serve. In 2007 and 2008 huge inflows of foreign exchange caused significant domestic liquidity issues, but the size of inflows has fallen off since mid-2008. The Economist Intelligence Unit forecasts that China's trade surplus will contract by more than one-third from US$361bn in 2008 to US$230bn in 2013. Inflationary pressure is also easing. The consumer price index is now in negative territory, and the fading away of the food- and oil-price shocks of early 2008 has also made sterilising foreign-currency inflows less urgent.

With the decline in one of its primary roles, the CIC has taken the opportunity to tighten up its operations, reshuffle staff and move into cheaper and less-risky assets. The company hired Zhou Yuan as the new head of its alternative-investment team in December 2008, in the hope that Mr Zhou's experience with UBS, a Swiss bank, would help the unit to improve returns. CIC's recent pursuit of mining investments--for example, with Fortescue, an Australian iron-ore miner--would also suggest a shift towards a more conservative portfolio, as officials seem to regard mining companies as safer and more consistent with national strategic goals than those in the financial sector.

"Go global" and prosper

Despite the easing of capital inflows, China will continue to have very large foreign reserves, and the CIC's mission will remain to diversify those reserves. As such, its investments will remain potentially controversial. The company is therefore keen to avoid the perception that it is on a mission to take controlling stakes in target companies' management or to buy up politically sensitive natural resources. Mr Lou underlined this in a speech in early April. He also stressed the CIC's adherence to the Santiago Principles, a new set of guidelines for sovereign wealth funds that China helped to draft. Undoubtedly, his efforts to present the CIC as a responsible investor are part spin, designed to reduce foreign opposition to the firm's investment plans. But they also suggest that the CIC will err on the side of making cautious and non-controversial investments for the next few years.

The CIC's low-profile approach contrasts with the more aggressive strategies of industrial state-owned enterprises (SOEs), whose investment bids--such as those in the mining sector--continue to make headlines. The SOEs' bolder strategy is being encouraged by the central government's "go global" policy (also referred to as the "going out" policy), the aim of which is to establish a larger Chinese presence in the international arena. The policy focuses on foreign acquisitions, brand-building and boosting international competitiveness. Chinese SOEs are being attracted by the low valuations of increasingly desperate foreign targets. Zheng Xinli, an influential economist with the Chinese Communist Party's top think tank, said in February 2009 that, with the exception of financial firms, China's SOEs should be bold in making overseas investments, particularly in strategically important sectors such as energy and resources. As international raw-material prices and shipping costs plummet, Chinese policymakers see a rare (and cheap) opportunity for Chinese enterprises to develop new markets abroad.

However, the global crisis swings both ways, and China has not gone unscathed. It seems that many Chinese companies, particularly in export-oriented sectors like high technology and textiles, are reluctant to risk overseas investments. Many have financial problems themselves. Despite the high-profile mergers and acquisitions being inked in the resources sector, a recent survey by a government trade promotion body showed that most firms are actually planning to cut down investment overseas.