CIC's home bias makes good sense
Lou Jiwei is making soothing noises. Last week the head of the US$200 billion China Investment Corp promised the mainland's new sovereign wealth fund would not destabilise international financial markets.
His reassurances are timely, given the growing nervousness among western politicians about the increasing influence of state investment funds in general and the murky objectives of the CIC in particular.
But his caution may not be driven solely by political expedience. It may also make sound investment sense.
Speaking last week, Mr Lou, a former vice minister of finance, said the CIC will be 'a stabilising force in the international capital markets', and that it could be up to a year before the fund is ready to begin making major foreign investments.
His comments follow confirmation last month that only around a third of the CIC's assets under management are to be earmarked for international investment. The rest is being used to acquire the mainland central bank's stakes in a clutch of state-controlled commercial banks and to help recapitalise Agricultural Bank of China and China Development Bank.
Clearly Mr Lou is anxious to calm fears that a sudden influx of mainland money could rock shaky international asset markets and to allay suspicions that the CIC is a front to help Beijing grab control of strategic industries in the United States and Europe.
His anxiety is understandable. Last month, US senator Evan Bayh told an influential senate committee on banking that 'a lack of transparency that characterises many sovereign wealth funds undermines the theory of efficient markets at the heart of our economic system.'
Meanwhile, rumours abound that Washington may block the proposed acquisition of a 16.5 per cent stake in US computer network company 3Com by Huawei Technologies on national security grounds.
And next week in Brussels, the European Commission is to discuss new rules to govern investments by sovereign wealth funds.
One obvious way Mr Lou can avoid controversy is by allocating funds to buy up the shares of mainland companies listed outside the mainland. Last week, for example, the CIC bought US$100 million-worth of shares in the Hong Kong initial public offering for construction and engineering specialist China Railway Group.
At first glance this strategy makes little sense. For the mainland's sovereign wealth fund to buy up stakes in state-owned companies would seem to negate the point of privatising them on international markets in the first place.
But on closer examination, it may be a sound policy. Mr Lou's brief is to earn a better long-term return on the state's foreign currency assets. That, as he has already discovered, can be tricky. The CIC's first investment, made back in June, was a US$3 billion chunk of US private equity company Blackstone. Unfortunately, Blackstone's shares have now fallen 26 per cent below their purchase price. To add insult to injury, the yuan has strengthened in the interval, meaning the CIC has now suffered a 28 per cent loss on its investment in yuan terms.
This illustrates Mr Lou's problem. To earn a positive return, he has to cover not only the CIC's cost of capital, currently 4.7 per cent, but also any appreciation of the yuan, which is expected to rise by around 10 per cent against the US dollar next year.
A 15 per cent return at acceptable levels of risk is not easy to come by in international markets. The benchmark US S&P500 index, for example, is down 1 per cent this year in yuan terms.
The simplest way for Mr Lou to hit his target is to buy internationally-listed shares in companies with yuan-denominated earnings, in order to provide a natural hedge against the mainland currency's appreciation. If those companies have good growth prospects, so much the better.
In practice, of course, that means buying up Hong Kong-listed H-shares and red chips, together with stock in a handful of mainland companies listed in New York, London and Singapore.
It looks as if Mr Lou's caution is not just sensible politics but good investment strategy.