CIC's 2012 Annual Report: What's New?

The most prominent SWF news over the past few days is China Investment Corporation’s release of its 2012 annual report, showing a strong 10.6% return.  China’s Global Times offers some highlights from the report:

The company’s overseas investment portfolio realized an annualized rate of return of 10.6 percent in 2012, compared with a return of negative 4.3 percent in 2011. And its accumulative annualized rate of return has reached 5.02 percent since its establishment in 2007, according to the annual report posted on the company’s website on Friday.

“CIC’s increased profit is mainly attributed to a global recovery, especially in the US stock market, since the second half of 2012,” Li Daxiao, director of research at Yingda Securities, told the Global Times on Sunday.

As a former securities lawyer and now a professor teaching about corporate law and disclosure, I was most interested in whether CIC’s disclosure about their governance and investment policies had changed from 2011.  

Well, in terms of the overall amount and structure of disclosure, things haven’t changed that much.  As in 2011, CIC’s report includes discussions of CIC’s governance structure.  As in 2011, the report describes CIC’s investment policies and provides examples of significant investments it has made (large stakes, passive investments).  As in 2011, the report provides a description of the investment management process.

I would call most of their disclosure changes “tweaks”.  For example, here’s a blackline (yes, I am a disclosure geek) showing the changes between the 2011 and 2012 investment policies section:

Investment Strategy and Portfolio Objectives

Investment Principles and Philosophies

CIC is committed to being a prudent, professional and responsible institutional investor operating globally with a good track recordreputation. Four basic principles underlie our investment philosophy and strategyactivities:

•             We invest on a commercial basis. The underlying investment Our objective is to seek high, long-term and sustainable financialmaximum returns for our shareholder within acceptable risk tolerance for risk.

•             We are a financial investor and do not seek to control any sector or companyof the companies in our portfolio.

•             We are a responsible investor, abiding by localthe laws and regulations in the of China and recipient countries we invest in and conscientiously assumingfulfilling our corporate social responsibilityresponsibilities.

•             OurWe pursue investments arebased on in-depth research-driven within our asset allocation framework to ensure sound,a prudent and disciplined decision-making process.

CIC follows a set of investment philosophies, which is firmly based on its institutional characteristics and understanding of investment decisions, and allocation-driven to guarantee a management:

•             Guided by the concept of CIC Portfolio, we take a holistic and disciplined approach.

Our investment philosophy can be defined as follows:

•             We take a holistic view in  to strategy design, portfolio analysisconstruction and management

 to ensure theportfolio integrity and consistency of our investment portfoliostability.

•             As a long-term investor, we are well positioned to withstand short-term volatility in markets, to pursue contrarian investmentsmarket volatilities and to build long-term positions that can capture theilliquidity premium for less liquidity.

•             We enhance the transparency and liquidity of public market assets to preserve the liquidity and flexibility of our investment see risk diversification as an effective way to control volatility and drawdown risk, which is central to CIC’s portfolio.


As always, there is plenty of interesting disclosure about how and where CIC is investing.  Here, for instance, are asset allocations for 2011 and 2012:




Money out of cash and into equities, primarily.  And where did CIC buy those equities?


Increasingly, from the U.S.  Note also a shift from energy and materials into more financial sector investments.

As always, the CIC report provides fascinating reading for SWF watchers.

What Happens to Detroit's Pensions in Bankruptcy?

The General Retirement System of Detroit and the Police and Fire Retirement System of Detroit recently filed a suit attempting to enjoin Governor Richard Snyder and Emergency City Manager Kevyn Orr from, among other things, “any action that causes the City’s pension debts to be subject to impairment under Chapter 9 of the United States Bankruptcy Code.”  In other words, declare bankruptcy if you want, but don’t touch our pensions.

The legal argument of the retirement systems goes something like this:

  • Governor Snyder and Emergency Manager Orr swore oaths to uphold the Michigan Constitution.  
  • Under Article IX, Section 24 of the Michigan Constitution, “the accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.”
  • The city owes the retirement systems and pensioners accrued financial benefits, which under the Michigan Constitution are contractual obligations.
  • By seeking to impair the accrued benefits by way of a bankruptcy proceeding, the Governor and Emergency Manager are violating the state constitution and breaking their oaths.

OK, but Detroit is broke and broken.  Something has to give.  Or perhaps it is better to say that everything and everyone has to give, including pensioners.  And in such cases, the law seems to me to be on the side of Governor Snyder and Kevyn Orr.  As Amy Monahan has argued in a piece I referenced earlier:

[I]t is well established that the [Constitutional] prohibition against the impairment of contracts “must be accommodated to the inherent police power of the State ‘to safeguard the vital interests of its people.’” . . . Courts undertake a three-part analysis to determine whether state actions that potentially affect contracts are unconstitutional under the Contract Clause. The first step is to determine whether a contractual relationship exists. Where the statute at issue is ambiguous, the court looks to whether “the language and circumstances evince a legislative intent to create private rights of a contractual nature enforceable against the State.”

The second step in a contract clause analysis is to determine whether the state action constitutes a substantial impairment of a contractual relationship. An impairment occurs if it alters the contractual relationship between the parties and is substantial—for example, “where the right abridged was one that induced the parties to contract in the first place, or where the impaired right was one on which there had been reasonable and especial reliance.”  

. . . Finally, if a substantial impairment is found, a court may nevertheless  find the change to the relevant contract constitutional if it is justified by an  important public purpose and if the action undertaken to advance the public interest is “reasonable and necessary.” In determining whether the action is aimed at an important public purpose, courts look to see whether there is a “significant and legitimate public purpose behind the regulation, such as the remedying of a broad and general social or economic problem.” Doing this ensures that the state is actually acting under its police power and not “providing a benefit to special interests.”  . . . In addition, in determining reasonableness the court takes into account the degree of impairment. The state’s action is considered to be necessary when (1) no other, less drastic modification could have been implemented, and (2) the state could not have achieved its goals without the modification.

Let’s stipulate the first part of the test has been met in favor of the retirement systems: there is an unambiguous provision in the Michigan Constitution stating that there is a contract here.  Let’s also stipulate that the city’s bankruptcy would result in a substantial impairment to their benefits.  It is not clear yet how much of an impairment the bankruptcy will bring, but no doubt it is going to be painful.

The last part of the test is where the case should be decided (by whichever court rules on the matter–and it may not be the state court, since the federal court handling the bankruptcy filing can adjudicate the state claim as well).  Is the bankruptcy action “justified by an important public purpose and the action undertaken to advance the public interest ‘reasonable and necessary'”?  It seems so to me.  If this isn’t a broad social and economic problem, I don’t know what you’d call it.  And Detroit’s pension obligations form a huge part of its debt burden– Detroit has $3.5 billion in unfunded liabilities–and no real solution to the problem seems possible without some (more) sacrifice by the pensions.  And certainly the pensions know that, and this case 1) simply demonstrates that the trustees of the pension funds are going to do their best to fight the good fight for the pensioners, and 2) serves as a bargaining chip to extract some concessions from the city (subject to court approval) in a bankruptcy proceeding.

 The pension funds think Orr is playing hardball by filing for bankruptcy.  I don’t think he had any other realistic choice, and he seems to be negotiating in good faith.  Don’t forget that Kevyn Orr knows how to manage such negotiations, having represented Chrysler in its bankruptcy. 



SOEs Hold Top Ten Positions of Fortune's China 500

As reported by (and probably the least surprising news of the week), SOEs dominate Fortune’s list of the largest Chinese firms: 

1. China Petroleum & Chemical Corporation

2. Petrochina Company Limited

3. China State Construction Engineering Corporation Limited

4. China Mobile Limited

5. Industrial and Commercial Bank of China Limited

6. China Railway Construction Corporation Limited

7. China Railway Group Limited

8. SAIC Motor Corporation Limited

9. China Construction Bank Corporation

10. Agricultural Bank of China Limited

China-U.S. Investment Treaty: A Crucial Development for Chinese SWFs and SOEs

The Wall Street Journal reports:

Senior U.S. and Chinese officials agreed Thursday to restart stalled negotiations to reach an investment treaty between the world’s two largest economies that could dramatically expand business opportunities for both countries.

The deal could open up more than 100 Chinese industries to investment by U.S. businesses, such as automakers, banks, and chemical and energy companies, that face restrictions on investment in that country’s fast growing economy. Chinese companies would win smoother access to the U.S., though both nations are expected to keep some strategic sectors, such as defense, off the table.

U.S. Treasury Secretary Jacob Lew, speaking after two days of strategic and economic talks, called the agreement “a significant breakthrough” in trade talks, and said a treaty “would work to level the playing field for American workers and businesses by opening markets for fair competition.” Workers in the U.S. services sector and other industries could benefit from new business in China.

Chinese Commerce Minister Gao Hucheng said, “We have agreed to enter a substantive state of negotiations as soon as possible.”

There are many moving parts in this negotiation.  Sen. Chuck Schumer argues that “[i]n previous talks, [the Chinese] have always seemed to get the better of us. To not address issues like theft of intellectual property, inability of American firms to freely enter the Chinese market, and currency manipulation and, instead negotiate things that might be an advantage to the Chinese would be a huge mistake.”  

We are, of course, talking about a bi-lateral investment treaty, which should allow much greater access to Chinese markets by US firms.  On the Chinese side, however, an investment treaty will be a crucial step in clarifying how CFIUS review of Chinese investments will take place.  A main concern of Chinese officials has been the seemingly ad hoc nature of CFIUS review for investments by Chinese SOEs and SWFs; a treaty can help clarify what types of investments will be forbidden and which are likely to be fast-tracked.  A review of the failed deals of the recent past–the Hauwei, Sany, A123 Systems and Smithfield deals most importantly–show the need for a new approach (read an excellent report on these deals by the Congressional Research Service’s James Jackson here).

As I and others have argued, the differences in risks presented by different countries are substantial enough that country-by-country treatment may be necessary; merely setting out a more robust set of CFIUS guidelines is not enough to deal with the risks associated with Chinese investment, in particular.




SWFs as a Catalyst for Islamic Finance?

As Indonesia is working to create a substantial and durable state-owned Islamic bank, it seems an opportune moment to reflect on why there aren’t more state-supported and sovereign wealth fund-supported Islamic financial institutions (with a few notable exceptions, such as Asiya).

Islamic finance is perhaps best known for its prohibition on the acceptance of riba (usury) and excessive risk, thus rendering many forms of interest-bearing instruments incompatible with sharia.  However, for many Islamic finance also has an important positive moral imperative; Islamic finance is a kind of socially responsible investing that is designed not to merely prohibit certain activities, but to actively promote socially beneficial activities.

SWFs seem ideal catalysts for this type of activity.  However, SWFs have been at pains to demonstrate to the world that they are purely commercial investors, perhaps explaining why they have not focused on “socially responsible” investing and values-based investing.  Along these lines, my SWFI colleagues Asim Ali and Shatha Al-Aswad produced a paper last fall looking at how SWFs and other government entities can promote Islamic finance and other forms of social investing.  They state:

We acknowledge that the advancement of Islamic Finance among SWFs has been anemic to date. Persian Gulf based states have avoided deploying their SWFs to invest in Islamic Finance. In doing so we believe they marginalize one of the most profitable and suitable investments for their long-term missions. Likewise impact investing has yet to be embraced by large-scale institutional investors, including SWF, principally for reasons of return and investment scale as each relates to their fiduciary or other stakeholder obligations. Both are formidable challenges, which will require creative solutions to overcome.

We believe that the principles of impact investing can reinforce and extend the social principles of Islamic Finance and its built-in risk management mechanism. These in turn can further strengthen the social values of impact investing. Both can form the foundation of an enlightened development agenda facilitated, at least in part, by sovereign investment vehicles. Bahrain and Malaysia, through their respective sovereign development funds, offer interesting cases in point. Could both build on their extensive expertise in Islamic Finance and leverage their SWFs to drive socio-economic development? Similarly can other Persian Gulf based SWFs – ADIA, SAMA, KIA, and QIA – leverage the structures of impact investing to serve their aspirations in building new cities and creating jobs through investments that enhance the quality of economic development and drive social impact?

The paper can be found here.



Challenges for Ding Xuedong, New Boss of China Investment Corp.

The job it seemed no one wanted–running China’s second largest and most prominent sovereign wealth fund–was recently accepted by Ding Xuedong, a former deputy finance minister.  So what challenges does he face in running the fund?  A Businessweek article lists three: boosting returns, finding new capital and dealing with rivalry from the manager of the nation’s foreign-exchange reserves (on this point the article’s author was wise enough to quote my SWFI colleague–and SWFI co-head–Patrick Schena). 

I am particularly interested in the first point, since it makes it clear why no one wanted the CIC job in the first place: the obsession with returns.  More than this, it is the obsession with annual returns that is so problematic.  And note that this concern with annual returns–a very real and legitimate concern given the political and public environment in which the CIC chief operates–seems out of step with what the CIC board has determined to be the appropriate way of thinking about returns.  Here is a quote from the 2011 CIC annual report:

We base our investment approach and benchmark portfolio structure on the mandate and investment policies set by the Board of Directors. In early 2011, the Board decided that the investment performance should be based on an extended 10-year horizon to reflect our long-term mandate and that a rolling 10-year annualized return would, over time, also be a major measure of performance. We accordingly adjusted our asset allocation structures—including the Strategic Asset Allocation and Tactical Asset Allocation—as well as our risk management processes.

Is there a tougher job in finance than navigating the CIC through the treacherous shoals of Chinese government oversight, Chinese public opinion, and host-country regulator (especially U.S. regulator) suspicion?  You only need to 1) earn at least 10% a year by 2) investing in (at least some) countries that don’t really want your investment, while 3) maintaining a “long-term mandate”. 

So, how much is this guy getting paid?


[Image: Blomberg]

New SWF Rankings

I have been very busy here in Qatar and have not kept up with blogging or news as much as I’d like.  So, this is my way of apologizing for being late on mentioning a fascinating new report that has just been published by ESADE and my Fletcher SWFI colleague Javier Capapé.  Among other things, they find that China’s SAFE is now larger than Norway’s GPF-G.

The update can be found here; the rankings are here; and the SWF tracker map is here.

Here’s a teaser screenshot from the tracker:


Great work by Javier and ESADE!