FT BeyondBrics. Change at CIC: As you were

FT BeyondBrics, January 22 2014

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The retirement of Gao Xiqing as president of the China Investment Corporation, China’s sovereign wealth fund, has fund managers wondering what the change of leadership will mean for asset allocation and the fund’s use of external managers.

Gao, one of the CIC’s founders, and instrumental in many of its most well-known (and sometimes ill-fated) deals, is to be replaced by Li Keping, who is the chief investment officer. This is the second change in top leadership positions at CIC in less than a year, with Ding Xuedong becoming chairman of CIC in July 2013.

Logically, one would not expect major changes with Li’s succession of Gao, as the two have a long-standing working relationship that predates CIC and appear to have similar views on investment strategy. They also worked together at the National Council for Social Security Fund (NCSSF) from 2003 to 2007, where, according to the leading Chinese fund management analysts Z-Ben, the two worked together to improve the fund’s investment returns and expand its overseas allocation. Since Li’s appointment, by Gao, to become CIC’s chief investment officer in 2011, there has been a broadly similar pattern at work of diversification.

CIC’s returns from year to year have been all over the place, although that’s partly a reflection of the behaviour of broader markets: a loss of 2.15 per cent in 2008, an 11.7 per cent gain in 2009, 11.7 per cent again in 2010, a loss of 4.3 per cent in 2011, and a positive 10.6 per cent return in 2012. Seeing this, CIC’s approach has evolved over time, from problematic early investments in US financial institutions such as Morgan Stanley, to increasing exposure to frontier commodity assets in places like Mongolia, to a balanced allocation more in line with sovereign wealth funds like the Abu Dhabi Investment Authority.

By 2011, the split was 25 per cent diversified public equities, 21 per cent fixed income securities, 11 per cent cash funds, 12 per cent alternative investments, and 31 per cent long-term investments (which includes private equity, energy, mining, real estate and infrastructure; absolute return funds, under the CIC definition, are mainly hedge funds).

However, in 2012, presumably with Li’s involvement, it changed direction once again. Its 2012 annual report explains how CIC reviewed the experience of institutional investors over the past five years, and decided to base its allocation on the endowment model made popular by Yale and Harvard, among others. It set a three-layered asset allocation framework combining strategic and tactical asset allocation styles with a policy portfolio, which means allocations based on mid-term economic projections. When CIC refers to the Endowment Model, this is likely to mean a steadily increasing focus on areas like private equity. This would fit with several investments made in 2012: CIC increased its focus on infrastructure, agriculture and other projects that generate steady returns, and says it developed a new private equity model. Direct investments in 2012 included Thames Water and Heathrow Airport Holdings in the UK, illustrating this increasing interest in proven, return-generating, developed world infrastructure.

It is this part of the portfolio we should expect to see continue to grow under Li’s tenure.

In addition, it is likely that the combined new leadership of CIC will deal with a long-standing oddity: Central Huijin. This is a subsidiary which contains the state’s holdings in China’s big banks. It has always been a strange part of the CIC portfolio. CIC’s annual reports exclude it when they calculate their performance numbers, yet its assets are normally included when figures are quoted for CIC’s overall assets under management.

It is at odds with anything else CIC does, since the sovereign fund generally invests everything overseas as a method of diversifying foreign exchange holdings. It would be reasonable to expect Ding and Li to separate the subsidiary entirely and focus purely on CIC as an overseas diversifier. It has also been suggested that divestments from Central Huijin could be used as a method to provide funds for CIC’s global portfolio.

And what of external fund managers? Like most sovereign wealth funds, CIC has steadily increased its in-house investment expertise over time, dividing its internal capabilities into a sophisticated group of dedicated investment teams. Curiously, though, this has not resulted in a decline in the proportion managed externally – in fact, quite the reverse. In 2009, 59 per cent of the fund was managed externally and 41 per cent internally; on December 31 2012, the figure stood at 63.8 per cent external, 36.2 per cent internal.

Partly, however, the proportion of internal and external management is a function of overall asset values; at the end of 2012 CIC had a total of $575bn under management. Whatever Li’s policy on external managers turns out to be – and there is little reason to expect a change – the rising asset totals from CIC, through consistent if irregular asset injections, are likely to leave a great deal for foreign fund managers to chase.