No More External Managers For China Investment Corp

370611_do_not_enterAccording to Z-Ben Advisor’s latest research report, the China Investment Corporation is planning a dramatic restructuring of its internal operations that will prioritize strategic direct investments and forego all portfolio and passive investments through fund managers. If your eyes aren’t bulging right now, you may need to reread that last sentence. Why? Because a $300+ billion Chinese SWF foregoing all external mandates would have some serious implications for the asset management industry. Here’s a blurb:

Z-Ben Advisors strongly suspects that CIC intends to embark on a major change to its investing practices, one that will put it out of the publicly-tendered mandate business. A new focus on internal management will form part of a plan to make private equity and alts the focus of the portfolio, turning CIC into an organization whose portfolio, preferences and needs will be- come much, much less like those of any other domestic or regional investor.”

And why would the CIC do this? Here’s Z-Ben doing a bit of ‘CIC executive role playing’:

“The amount of value that outside managers of funds, which invest in public markets can add, compared to our own ability to manage those investments, has shrunk to nothing, so let’s stop hiring them. Our access to the emerging markets that interest us most is constrained by global managers’ home and large-market biases, so if we’re going to hire more managers, let’s hire them locally or internally. We can earn much better returns, over the long run, by owning large and illiquid things for which there are few buyers, rather than competing with everyone else for things which are small and liquid, so let’s make the large and illiquid the core of our portfolio. The best way to make money out of large and illiquid things is to manage them directly, so let’s be co-investors or general partners in those investments, not limited partners dependent on someone else’s skills and interests.”

While I don’t want to fan the flames too much (due to the unpredictability of this fund’s behavior), I have to say that I don’t really disagree with any of the statements above. In fact, you don’t have to resort to role playing to justify these beliefs: you can get it directly from CIC executives on film. So, while this may seem a bit radical, it is a realistic option.

In fact, a more strategic approach from the CIC would jive with some of things we’ve been saying in our own research program. For example in our ‘Form and Function’ paper, Gordon and I suggest that the CIC (and other SWFs) will eventually forego portfolio investing and move into a more strategic approach. Moreover, in our (recently revised) paper on the CIC, we argue that investment behavior of the fund thus far would seem to suggest that many strategic objectives are already in play:

“Instead of thinking of the CIC as an investor governed by the long-term risk-adjusted rate of return on its investment portfolio, it may be better to think of the CIC as an arm of the Chinese government just like other state-owned enterprises concerned with its resource needs and its status as a global power.”

This, by the way, is a view that also matches up with Haberly’s recent paper on the Chinese SWF.

And yet, it’s not all pointing towards a strategic shift. The CIC has been performing remarkably well in its “portfolio” investment operations. It’s been one of the best performing institutional investors in the world over the past three years. Therefore, re-tasking the Chinese SWF would, in effect, be scrapping a winning strategy. Moreover, giving the fund a strategic focus would potentially have two negative outcomes:

It could upset target countries that have (seemingly) come to accept the CIC in its current guise. Recall that much of the fear mongering in the West was focused on the potential for strategic investing within the CIC.

It will increase the likelihood of Morgan Stanley and BlackRock type investment flops. If the CIC is investing for the benefit of the nation-state and not exclusively focused on the fund, then it may be willing to overpay for certain (strategic) assets. This means that the financial returns we’ve seen over the past few years won’t be sustained, and the domestic audience will once again grow frustrated with the fund’s performance (as occurred in 2008).

Both of these outcomes would place the CIC in a rather precarious position — both internationally (e.g., protectionism) and domestically (e.g., legitimacy). And for this reason, I remain circumspect but intrigued by the possibility.

This post originally appeared on the Oxford SWF Project website.