CIC Bullish on Developed Economies | Chief Investment Officer

(January 15, 2014) — The China Investment Corporation (CIC) will remain heavily invested in developed markets, despite some regulatory difficulties with investing in the US.

Chairman and CEO Ding Xuedong told CNBC his sovereign wealth currently invested more than half of its ¥3.5 trillion ($500 billion) in developed economies, and planned to remain overweight for the foreseeable future.

“This is because we are seeing a strong economic rebound in the US over the past two years and Europe is also in recovery,” he said.

In 2013, CIC President Gao Xiqing told CNBC that the US regulators had “singled out” the CIC “as a different investor”.

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During today’s interview, Ding said the CIC does face regulatory constraints in “certain countries, sectors and projects”, but highlighted the UK as being easier to work with, thanks to its open and friendly approach to overseas investors.

This strategy does not preclude further investment in emerging markets, however. Ding also said he saw opportunities in the sector, and planned to raise its investments there over the next year.

“In the long run we are bullish in Asia and other emerging countries,” he added.

Ding also expanded on his diversification plans for the sovereign wealth fund. Historically, the CIC had been heavily invested in energy, but since Xuedong arrived in the CEO and chairman role, he has taken steps to divest from the sector.

In September, the fund converted its bond holdings in Russian potash producer Uralkali into a 12.5% equity stake, becoming the miner’s second largest shareholder. This was Ding’s first major decision as chairman.

This move and others suggest Ding is diversifying the CIC’s portfolio away from the energy sector in favour of agricultural assets. China is already the biggest potash consumer in the world, using more than 10 million tons last year in order to boost crop yields. As China’s population continues to grow, so will its demand for the fertilizer. With a major equity stake in Uralkali, CIC will be able to secure an advantage in future price negotiations.

Speaking to CNBC, Ding said: “Since the global financial crisis, especially in the last two years, the returns from energy investments have not been great. Going forward, we may continue to invest in the sector but we will be extra careful.”

Ding also confirmed that the CIC “might increase our investment in agriculture and food”, adding that real estate and infrastructure looked attractive too.

“I am interested in investment opportunities in infrastructure around the world. In the next five to 10 years, infrastructure investment will be a big theme for both emerging and developed markets. We want to increase our investment to get better returns,” he said.

(January 15, 2014) — Pre-crisis accounting measures have masked the correlation between public and private equity returns, and led investors to believe they are getting better returns than they really are, a new paper has found.

Kyle Welch, a former member of Stanford’s endowment team now a doctoral candidate at Harvard Business School, said changes in international accounting standards had laid bare just how closely related public and private equity returns are—and what these new measures mean for private equity funds.

Welch said that despite research to the contrary, “those marketing private equity assets continue to emphasize its diversification value, and demand for private equity investments has surged”.

Private equity assets sit at around $3 trillion worldwide, according to Preqin, and have grown steadily since the onset of the financial crisis.

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Investors have been led to believe that the assets held in private equity funds would diversify the risk and return of their portfolios, but Welch claimed it was possible to see how this was widely untrue.

“Exploiting the change in international accounting, I show that returns provided by private equity firms understate the economic movement between private equity and market returns, creating a diversification illusion,” the paper said. “I find that private equity funds that adopted re-defined fair value accounting reported returns with increased market beta and correlations. Additionally, I find that abnormal returns to private equity firms disappear after adopting fair value standards.”

The new accounting methods that have been adopted are FAS 157 in the US and IAS 39 internationally. Under prior methods, a number of assumptions made allowances for illiquidity and conservative reporting. New standards assumed transactions of assets between willing parties, and restricted the previous methods of using historical costs as a measure of fair value.

Welch’s calculations found firms implementing updated fair value standards reported twice the market beta—and all alpha disappeared.

“Not only do assets move more closely to the market than previously reported but managers also benefited from transferring beta returns to alpha returns.”

He then cited Yale Endowment’s David Swensen to support his hypothesis on the lack of diversification and investor willingness to commit capital.

On this last point, however, it is the private equity funds themselves that stand to lose out by adopting the new accounting measures, Welch claimed.

“Firms implementing fair value standards exhibited a lower propensity to raise capital, raised less capital overall, raised less capital for each day they were in the market and raised less capital per investor,” the paper said.

These companies also spend more time soliciting new investments and bring in around 50% less capital than their counterparts.

To read the entire paper, click here.