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Contrasting styles between Singapore and China borne of necessity

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Why is the CIC’s investment approach more aggressive than GIC’s? Because it has to be. As State Street’s recent report, ‘SWFs - Assessing the Impact’ explains: “Norway’s sovereign fund represents ‘net sovereign wealth’ or net public saving, insofar as it is an equity-like claim by the government on the underlying assets. China on the other hand, funded the CIC by a transfer of foreign currency reserves from the central bank against a renminbi liability of the government.

In other words, the Chinese government issued local currency debt to fund CIC’s assets. If a sovereign wealth fund is debt-based, as is clearly the case in China, it appears to introduce additional constraints and complications on the asset side of the balance sheet. In effect, the cost of local debt and the expected appreciation of the local currency become the ‘hurdle rate’ which the fund must beat in order to be economically viable over the long-term.

For example, if one assumes, very conservatively, that the annual cost of local debt is 4% and the expected annual appreciation of the renminbi is 5%, China’s newly launched SWF will need to make at least 9% annually just to break even. As most observers expect inflationary pressures to rise and the renminbi to appreciate much faster, the actual hurdle rate is probably going to be significantly higher. To put this in perspective, consider that Singapore’s GIC has produced an annualised nominal rate of return of 9.5% over the 25 years of its existence. However, this was arguably one of the most benign periods of global disinflation, secular declines in interest rates and rising stock markets. Today senior officers at GIC acknowledge that it would be more realistic to expect annualised returns in the range of 6 to 8% going forward.

In these circumstances it may be more optimal for China to model CIC on the likes of Temasek of Singapore, rather than Norway’s fund. After all, the more concentrated, private equity-like strategic investment style of Temasek has delivered compounded annual returns in excess of 18% over the 33 years of its history, with the more recent record showing even more impressive performance.

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