Chinese SWFs play key role in outbound investment drive
As China transitions from a sovereign wealth accumulator to a sovereign wealth manager, it is reforming and expanding the function of government and quasi-governmental investment vehicles to reflect a more active overseas investment strategy.
China Investment Corp is undergoing major restructuring and is now explicitly targeting overseas fixed asset investment; China Development Bank is becoming more active in its overseas funding activities; and the People’s Bank of China and State Administration of Foreign Exchange are exploring more active management strategies for the country’s $3.2 trillion foreign exchange reserves.
Speculation that China might deploy a portion of its foreign exchange reserves to “save” Europe seems unfounded, but increasing outbound investment has emerged as a policy priority in Beijing over recent years. The authorities see outbound investment as a mechanism for reducing the surplus-to-GDP ratio (thereby reducing inflationary pressure) and improving returns on the considerable sovereign wealth accumulated since 1979. And while Beijing is unlikely to sanction financial investments perceived as overly-risky, infrastructure and fixed asset opportunities hold greater appeal for innately cautious Chinese.
In the second half of 2011, the National Development and Reform Commission released a number of guidelines that establish a provisional framework for Chinese investors to “go global”, including Tentative Measures for the Administration of Overseas State-owned Assets and Equity of Enterprises Directly under the Central Government.
Meanwhile, CIC continues to restructure into more clearly-defined domestic and overseas divisions. Members of its senior management have also recently stated a strong desire to expand their exposure to European fixed assets, particularly in the government’s strategically-favoured sectors such as conventional and clean energy, telecoms and media, and construction.
Another significant development has been an expansion of the overseas focus at CDB. IPA understands CDB has recently established a specialised overseas investment department, while there has been a healthy and diverse flow of deals in recent months. These range from copper mining in Kazakhstan to oil production in Venezuela; the extension of substantial loans for Chinese renewable energy companies targeting overseas expansion; and an exclusive deal for investment in both China and overseas with private equity house Permira.
The PBOC and SAFE are also looking to develop more active management strategies for tranches of China’s forex assets. “It is not surprising that China is interested in investing in infrastructure in the West,” says Simon Baxter, Head of Lenders & Investors Asia at EC Harris.
“According our recent research, which ranked 17 countries across the globe according to the relative attractiveness of their transport sector to potential investors, investors felt more comfortable putting funds into more established economies where the regulatory regime is better developed and where there is a lower level of political and economic risk.”
While suiting Chinese risk-reward profiles generally, the apparent preference for fixed asset investment is logical given current market uncertainty, according to Lily Fang, Associate Professor of Finance at INSEAD. “Focusing on fixed assets is probably a reaction to uncertainties in the currency market. Real assets offer a natural hedge against currency fluctuations and inflation.”
Along with potentially attractive risk reward profiles in the current environment, China’s move toward greater sovereign wealth fixed asset investment is also part of a broader regional trend, according to EC Harris’ Baxter. Infrastructure funds are in the ascendancy. Now that a number of lessons have been learnt about the need to focus on specific segments with expert knowledge rather than investing in a broad cross section of asset classes across vast geographies there are success stories and solid performance being achieved.
Absence of a track record
However, challenges remain, particularly a lack of experience and a sparse track record of successful deals. “Institutional infrastructure investment is a relatively recent development and growth area. There is clearly the need for the asset management capability of these investors to mature and only then will we see significant deal flow. At present the volume is low. In China specifically, the lack of track record and deal structure experience has meant that while many deals have been developed, few have been closed,” Baxter adds.
INSEAD’s Fang also highlights potential resistance on the part of would-be foreign partners. One specific challenge for Chinese SWFs may be political: that is, a potential backlash from foreign countries if these investments are perceived as predatory. Strategic assets also may be difficult to acquire, she says.
As the deal flow increases and Chinese institutions build out their track records, concerns from policy makers on both sides may begin to fade. Chinese sovereign investment entities and the authorities in Beijing should become more familiar with overseas investment environments and more comfortable increasing their exposure to them. Meanwhile each successful deal will enhance the credibility of those entities with would overseas partners, be they commercial or governmental.
However, it may take several years for this evolution to occur. Given the high degree of uncertainty at present in global markets, Chinese policy makers are likely to maintain a gradual pace of reform. And until a fuller policy framework is in place and the internal structures and functions of China’s sovereign wealth entities have become more transparent, foreign partners are likely to retain a degree of reticence.
So while China is unlikely to use its sovereign wealth as a “big bazooka” to blast developed economies out of their present doldrums, a more active, fixed-asset focused investment strategy from Beijing has the potential to provide sustained and increasingly broad-based support going forward.