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China’s CIC Boosts Direct Investments in Search of Returns

Chairman Ding Xuedong overhauls management and strategy at sovereign fund; will closer ties with Beijing frustrate efforts to expand in U.S.?

  • By Allen T. Cheng

Bespectacled and with a professorial demeanor, Ding Xuedong smiles broadly as he walks the hallways of China Investment Corp.’s headquarters, but the staff knows full well that the chairman carries a big stick.

Since taking the helm of CIC in July 2013, Ding has restructured China’s influential sovereign wealth fund by overhauling top management, shifting power over its $250 billion global portfolio from a handful of individual managers to investment teams, and conducting periodic audits to guard against corruption and conflicts of interest between managers and the investments they make.

Current and former staff recall how in his first months on the job Ding asked some of the more senior of CIC’s 400-plus employees to submit “self criticism” reports reminiscent of the methods used in political purges during Mao Zedong’s Cultural Revolution in the 1960s and ’70s. Those who refused risked being shown the door. Those who complied had to detail all of their errors, apologize for them and promise never to repeat them.

The new boss represented something of a culture shock for CIC. Launched in 2007 with $200 billion of the country’s prodigious foreign exchange reserves, the fund recruited dozens of China’s leading investment professionals, many of them trained on Wall Street, and gave them authority to make bold investments in everything from Western banks and fund managers, such as Morgan Stanley and Blackstone Group, to leading hedge funds. Ding wants to retain CIC’s entrepreneurial spirit, but he insists that key decisions be made by teams of investment professionals rather than by individual managers.

“I wanted us to take an institutional investor approach to investing,” Ding says in an interview in his conference room on the 19th floor of CIC’s New Poly Plaza headquarters building in Beijing. “I wanted us to build an organization that is made up of teams of outstanding investment professionals and project managers.”

Ding has put his own firm stamp on CIC. His self-criticism exercise, which foreshadowed tactics that President Xi Jinping would employ when he launched his national anticorruption campaign a few months later that year, marked a new era in two ways: It imposed Ding’s authority at the head of the sovereign fund, and it redefined CIC more clearly as an arm of Beijing’s economic and financial policy — and not a mere portfolio investor.

“Chairman Ding is loyal to the central leadership and representative of an era of being conservative in all things, including investments, consolidation rather than expansion, and political correctness over risk or entrepreneurial flamboyance,” says Laurence Brahm, a Beijing-based lawyer, entrepreneur and adviser to the Chinese government.

Among the top executives who have left under Ding’s reign: Gao Xiqing, a former Wall Street lawyer and banker who helped launch the sovereign wealth fund nine years ago and served as its first CIO and later as president, and Peng Chun, a senior aide to Gao who served on the fund’s executive committee and returned to his former employer, Bank of Communications, as president. Ding initially tapped Gao’s successor as CIO, Li Keping, to become president. Li had previously been deputy chairman of the National Council for Social Security Fund, a supplementary state pension fund. After Li’s retirement in June, Ding went outside CIC to fill the presidency, tapping Tu Guangshao, former head of the Shanghai Stock Exchange and executive vice mayor of Shanghai. Tu oversaw a number of recent financial liberalizations, including the launch of Shanghai–­Hong Kong Stock Connect and a pilot program opening the city to foreign hedge fund managers. He briefly served under Xi in 2007, when the future president was party chief of Shanghai. Neither Tu nor Li has ever lived outside the mainland or worked for an international financial company. Ding has not named a CIO since Li’s retirement.

In addition to revamping senior management, Ding has made an important shift in investment strategy, taking direct stakes in partnership with leading Chinese companies, primarily state-owned enterprises (SOEs). Last year the sovereign fund created a subsidiary, CIC Capital, to lead the new push by taking a private equity–style approach toward offshore investments in areas including real estate and infrastructure. It also formed a new, independent real estate department that can make investment decisions on its own. In the past 18 months, CIC Capital has led Chinese consortiums in several major deals, including the $920 million purchase of a 65 percent stake in Kumport, Turkey’s third-largest container port. The real estate department conducted the acquisition of ten shopping malls in France and Belgium from CBRE Global Investors for $1.44 billion and the purchase of nine office towers in Brisbane, Melbourne and Sydney from Australia’s Investa Property Trust, a Morgan Stanley subsidiary, for A$2.45 billion ($1.8 billion).

Next on the chairman’s radar screen: the U.S. Last December, Ding shut down CIC’s North American headquarters in Toronto — its only overseas office — and relocated the team to New York. “We are not satisfied with the composition of our investments in the U.S.,” Ding says. “We hope to increase our direct and private equity investments in the U.S.”

Yet the way Ding has reshaped CIC could frustrate his ambition of growing the fund’s U.S. footprint. American politicians have long been wary of a potential influx of investment from state-run Chinese entities. In 2005, congressional opposition effectively torpedoed China National Offshore Oil Corp.’s bid for Unocal Corp. Washington was influential in getting sovereign wealth funds to sign the Santiago Principles, a 2008 voluntary agreement under which funds commit to invest primarily for economic and financial returns rather than for political or strategic objectives. Donald Trump has based much of his presidential campaign on the contention that China has stolen jobs from Americans through unfair trade practices that he will stop.

CIC must be careful not to be seen as a Beijing policy arm if it wants to grow its U.S. investments, says Brad Setser, who is senior fellow at the Council on Foreign Relations in New York and served as deputy assistant secretary for international economic analysis in the U.S. Treasury Department from 2011 to 2015. “Generally speaking, my guess is that the more the CIC supports China’s strategic initiatives globally, the more questions its investments in the U.S. will generate,” he says.

Ding insists CIC’s priority is to maximize returns on the government’s reserves — nothing more than that. He rejects the criticism that CIC is run like a ministry as unfair, pointing out that the fund often bids for assets in consortiums with foreign companies as well as private Chinese businesses. “We will not invest just because we’re told to,” he says. “The decision to invest or not invest rests in our hands. I want to make it clear: We will not invest if we believe we will lose money.”

Some observers wonder if CIC is losing its appetite for overseas investments. They point to recent purchases that the sovereign fund has made within China — something CIC has rarely done — including taking stakes in Didi Chuxing, the Chinese ride-hailing app, and Ant Financial Services Group, the Internet finance affiliate of e-commerce giant Alibaba Group Holding. “They are supposed to be outward-bound, but a few recent China deals came up that CIC couldn’t pass up,” says Andrew Collier, head of Hong Kong–based independent research house Orient Capital Research. “Some people say they are politically constrained because of policies and that they could be under pressure to invest back in China.”

What underlies all these moves is a need to generate returns in an increasingly difficult environment, a challenge Ding shares with many investment managers. Here CIC has been anything but immune to the volatility and dwindling rates of return that bedevil investors around the world. CIC posted a return of –2.96 percent on its global investment portfolio in 2015, compared with a positive return of 5.47 percent in 2014. Losses on energy and commodities and the strength of the dollar (CIC’s reporting currency), which hit investments in emerging markets, were mainly responsible for the negative return, fund executives say. That decline, which compared with a 3 percent drop in the MSCI World Index last year, reduced the fund’s annualized return since inception to 4.58 percent at the end of 2015 from 5.66 percent a year earlier.

“If there is any phrase that sums up 2016, it’d be the word ‘uncertainty,’” Ding says. He cites political uncertainty first and foremost, including questions about the impact of Brexit on the U.K. and the European Union, and the outcome of the U.S. presidential election and a potential shift in U.S. policy under President Obama’s successor. “Add on top of this the ongoing economic restructuring in China and the pressures on maintaining current levels of growth, and we can say the coming year will be full of challenges and uncertainty,” he says.

CIC is not the only sovereign wealth fund that has suffered in the past year. Singapore’s GIC reported that its 20-year annualized rate of return fell to 4 percent in the year ended March 31, down from 4.9 percent a year earlier, according to Institutional Investor’s Sovereign Wealth Center. The Abu Dhabi Investment Authority’s annualized rate of return over the past 20 years dropped from 7.4 percent in 2014 to 6.5 percent in 2015, according to the center.

Losses notwithstanding, Ding — who looks young for his 56 years and plays tennis and swims several times a week to keep fit — appears very secure in his perch atop CIC. The chairman has risen quickly to the senior ranks of China’s policymaking establishment and enjoys close ties to the aides of the country’s top leaders. He was vice minister of Finance from 2008 to 2010, then served for three years as deputy secretary general of the State Council, the powerful agency run by China’s premier that supervises the 25 ministries that make up the central government in Beijing. While at the State Council, he was chief of staff to vice premier Hui Liangyu, who oversaw China’s vast agricultural economy. At CIC he replaced the fund’s founding chairman, Lou Jiwei.

“His predecessor is now minister of Finance, and he is on his way up, too,” a Beijing-based European banking executive who has advised CIC in the past says of Ding. Many in Xi’s leadership team, which took power in 2013, felt that CIC’s previous management was “too international and aggressive, and wanted to send someone they can trust to rein it back,” the banker elaborates. “They sent Ding in to make it more disciplined.” Many of the top executives who helped get CIC off the ground were educated and trained overseas and speak fluent English, such as Gao, who earned a law degree from Duke University and worked for a Wall Street law firm, and Jesse Wang Jianxi, the fund’s former chief risk officer, who left CIC just before Ding arrived in 2013 and now serves as chairman of the Beijing Dalio Public Welfare Foundation, an organization supported by Bridgewater Associates founder Raymond Dalio that works with orphaned and disabled children.

China’s top leadership has rewarded Ding for his efforts. In addition to CIC, he now chairs two of China’s most powerful financial institutions. In December 2013, shortly after taking over CIC, he assumed the chairmanship of Central Huijin Investment, the CIC subsidiary that owns majority stakes on behalf of the government in many of China’s leading financial institutions. They include Industrial and Commercial Bank of China, China Construction Bank Corp., Agricultural Bank of China and Bank of China, which are, respectively, the world’s first-, second-, third- and fifth-largest banks by assets.

As chairman, Ding oversees board appointments but for the most part does not take an active role in managing the 18 financial institutions in Central Huijin’s portfolio. He made an exception for China International Capital Corp., the nation’s leading international investment bank, which was founded in 1995 as a joint venture between China Construction Bank and Morgan Stanley. Though he had no capital markets experience, Ding took over as chairman of CICC in October 2014 and oversaw the company’s restructuring and $811 million initial public offering in Hong Kong last November.

“He is now holding a number of portfolios, and this is unprecedented, as these portfolios should be separate,” says government adviser Brahm. “Ding’s chairmanship of all three is more indicative of the current political environment of centralizing control over everything.”

CIC does not break out results for Central Huijin, but its 2015 annual report lists Huijin’s assets as being worth $563 billion. The subsidiary has grown by 230 percent since CIC’s founding, reflecting the rapid expansion of China’s big banks, but it is not an active investment portfolio in any sense. There is a firewall between the assets of Central Huijin and CIC’s investment portfolio, and dividends earned in each portfolio must be reinvested in the same portfolio.

Asked if rising bad debts in China’s banking system could hurt Central Huijin’s assets and slow CIC’s asset growth, Ding says he is not worried. “We do notice that nonperforming loans are rising in China’s banking system and putting downward pressure on bank profits, but I don’t see it as anywhere near a crisis or creating systemic risk,” he says. “Authorities and banks are taking measures to contain the bad debts, and I remain confident about China’s economy as a whole.”

Ding was born and raised in the city of Changzhou, northwest of Shanghai. He excelled at math in school and studied the subject at university. His disciplinarian approach harks back to his days in the mid-‘90s as a senior official in charge of audits and anticorruption efforts at what would become the State-Owned Assets Supervision and Administration Commission. While there he earned a Ph.D in economics from the Finance Ministry’s Research Institute for Fiscal Science in 1997. He left the agency the following year to become director of the Agriculture Department at the Ministry of Finance.

He set an early tone at CIC by instituting the self-criticism exercise, in which many senior employees critically examined their work and acknowledged their mistakes. One former employee, speaking on condition of anonymity, says he had to submit several drafts of his self-criticism to Ding before it was approved. “I wrote 4,000 words in my first draft,” he recalls. “Ding told me it wasn’t enough. I then submitted 8,000 words, and he told me to write more than 10,000 words. It was only when I submitted 12,000 words and gave a long, detailed list of mistakes and errors and vowed never to repeat them that I was finally told I’m off the hook.”

Ding has “shaken up the empire and instilled discipline,” says a Beijing-based Western banker who has done many deals with the fund. “In the past, investment stars could rest on their laurels and get away with a lot of lax behavior. Today, under Ding’s hawklike eyes, everyone is on the alert and focuses on driving performance not only for themselves but for their teams.”

At internal meetings the chairman constantly makes investment team members review performance, zeroing in on mistakes. “If an investment fails, we will conduct an audit,” he says. “We may cut the manager’s bonus or even impose punishment, such as firing someone for improper or negligent conduct.” That approach is essential to boosting performance and growing the fund’s portfolio, Ding insists. “I believe I have built at CIC a strong institutional framework that can maximize returns and minimize risks,” he says with a smile. “We are on track to grow CIC into a $1 trillion sovereign wealth fund,” he adds, combining CIC’s global portfolio with Central Huijin. “I believe we will achieve that between 2018 and 2019.”

CIC International, which manages the bulk of the investment portfolio, requires every department — asset allocation and strategic research; public equity; fixed income and absolute return; private equity; and real estate — to vet investment ideas well before they are submitted to the investment committees. CIC Capital, the direct-investment arm, does the same with its two departments: one overseeing infrastructure, mining and energy; the other in charge of all other areas.

“Every investment proposal must have a thorough analysis of the risks and the potential profits,” Ding says. “Every decision is not made lightly. I give a lot of power to investment committee members. I also tell them I give them the power but at the same time I give them the responsibility.” The staff has grown to 592 people, including 466 investment professionals, since Ding took over.

The chairman says CIC plans to launch an in-house research unit next year to support the investment teams. Although he declines to share details about the timing or scale of the operation, he says researchers will focus on macroeconomic, industry and sector trends, as well as on individual companies, and will assist investment teams with due diligence and asset allocation strategies. “All major global investment houses have professional research teams, and we at CIC must have one as well,” he asserts.

Direct investments will play a key role in trying to fulfill Ding’s ambitions. They have declined as a share of CIC’s investment portfolio, to 22 percent last year from 26 percent in 2014, reflecting lower valuations of some investments, mainly in commodities and Canadian energy companies, but Ding is determined to grow this segment. Public market equities make up 47.47 percent of the portfolio, while direct long-term investments account for 22.16 percent, corporate and government bonds 14.44 percent, absolute-return and hedge fund strategies add 12.67 percent, and cash and liquid instruments chip in 3.26 percent.

The Kumport deal in Turkey, sealed last November, best illustrates Ding’s emphasis on working with other Chinese investors, especially major state-owned industrial and financial conglomerates. CIC Capital teamed up with China Merchants Holdings (International), an arm of one of China’s leading private sector banks, and with COSCO Pacific, part of state-owned China Ocean Shipping (Group) Co., to establish a special-­purpose company to make the acquisition. The Turkish port complements COSCO’s stake in the nearby Greek port of Piraeus.

“We take strategic stakes by coinvesting with many others, including state-owned enterprises,” Ding explains. “We focus on mature enterprises with existing revenues and profits. We avoid greenfields because we don’t participate in management, and that is why we prefer to invest with expert enterprises that can help oversee management.”

A senior real estate banker with CIC who spoke on condition of anonymity says the sovereign fund “doesn’t have the manpower and lacks sector expertise,” and is always looking for investment partners that have “deep domain knowledge and experience, and who can send staff to help supervise” any new acquisitions. “Many Chinese SOEs are looking for acquisitions offshore, and it is only natural they partner with CIC,” the banker says. “We work in consortiums not because we have an ambition to take over the world or to impose Chinese hegemony. We partner because it makes business sense.”

Whether such partnerships will work in the U.S. remains to be seen, but Ding faces a challenge in turning around CIC’s performance in North America. He took his first big step in December by shutting down the fund’s Toronto office. CIC had opened that office in 2011 because it had developed a taste for Canadian oil and gas properties.

In 2009, CIC invested $500 million in Vancouver-based SouthGobi Resources, a company with substantial mining operations in Mongolia, and $1.7 billion in Vancouver miner Teck Resources. In 2010, CIC invested a total of $1.9 billion in four Calgary-based oil-sands companies: $500 million in the IPO of Athabasca Oil Corp., which was considered one of the most overpriced public listings in Canadian history; $1.25 billion in a pair of deals with Penn West Petroleum, which became mired in an accounting scandal and other problems; $150 million in Sunshine Oilsands, a junior oil-sands company that had to halt development of one major project because of financial difficulties; and MEG Energy Corp., in which CIC invested $100 million before the company went public. Shares in all of CIC’s Canadian holdings have plunged by more than 50 percent since the peak of 2009 and are a long way from recovering.

“The fall of the price of oil is far bigger and longer-lasting than we thought,” Ding acknowledges.

In 2014, CIC sold a 4.5 percent stake — one third of its holding — in Singapore-listed commodities trader Noble Group for a reported S$310 million ($229 million). That sale was struck at a price of S$1.32 a share, or some 37 percent below the level at which CIC began building its stake in 2009.

In shifting CIC’s focus to the U.S., Ding is moving away from energy and targeting areas such as technology, infrastructure and real estate. Roughly 40 percent of CIC’s portfolio already is exposed to U.S. assets, mostly through equity and bond mandates handed out to fund managers, but Ding believes there is room to grow the exposure through direct stakes. He worries, though, about potential political and national security roadblocks, and the need in many cases to gain clearance from the interagency Committee on Foreign Investment in the United States (CFIUS). The U.S. regulatory system “is not transparent and quite difficult to maneuver,” he says.

Ding has yet to appoint a head of the five-person New York office. Winston Ma, a former Barclays Capital equity capital markets banker who joined CIC and ran the Toronto office, was transferred in December back to Beijing, where he continues to work on overseas acquisitions.

Although some Chinese entities have been successful in investing in real estate in the U.S., few have succeeded in large-scale infrastructure. A recent failed attempt by Chinese state-owned high-speed rail companies to invest in a high-speed line connecting Las Vegas and Los Angeles illustrates some of the difficulties. XpressWest, the Nevada company developing the rail line, terminated its joint venture with China Railway International U.S.A. Co., a consortium that includes China Railway Corp. and China Railway Engineering Corp., primarily because of federal requirements that high-speed trains be manufactured in the U.S.

Ding has instructed his aides and researchers to closely study the U.S. regulatory and political landscape. “We want to better understand and communicate with officials in the U.S. regulatory system,” he says. He vigorously defends CIC’s right to do business in the American market, saying the fund invests purely for financial returns. “Our ties with government are clear,” he says. “We are independently run, independently audited. We use global institutional investor standards in making investing decisions.”

Many experts believe CIC should be able to make headway in the U.S. “As long as those investments do not infringe on vital U.S. technology and core infrastructure, I see no issue with more CIC investment in the U.S.,” says Victor Shih, an associate professor of political science at the University of California, San Diego, and an expert on China’s financial sector development.

Yet some observers question CIC’s ability to grow its U.S. footprint, largely because of the changes Ding has made at the fund. “CIC bankers in the past seldom talked about the power of China Inc.,” says one senior European banker, who has taken CIC executives on numerous road shows and who spoke on condition of anonymity. “But under chairman Ding many of the new executives do not shy away from bragging about how powerful CIC and its state-owned partners are. They often use their collective power as a negotiating strategy in outmuscling rivals when deals get tough.”

Ding does have some notable American allies. Back in 2007, even before CIC formally opened, former chairman Lou’s team made one of its first investments by putting $3 billion into buyout firm Blackstone Group right before its IPO, which was priced at $31 a share. Those shares tumbled as low as $7 during and after the financial crisis, and were trading late last month at $28.23. “Our investment in Blackstone is now net positive,” Ding says. “It’s not as high as we would like, but we have made money. In the process, we formed a strong long-term investment strategic partnership with Blackstone, and through the partnership we received a lot of training.”

CIC has also invested with Carlyle Group, committing $350 million to the private equity firm’s sixth flagship fund two years ago. “CIC employs one of the toughest and most rigorous due-diligence processes of any investor with whom we have experience anywhere in the world,” says Michael Arpey, head of investor relations at Washington-based Carlyle. “They have highly professional teams, a sophisticated process and clear objectives in terms of what they seek in an external manager.” In 2011, CIC bought an unspecified preferred-equity stake in 650 Madison Avenue, a 27-story building that Carlyle owns.

Ivan Shi, a director at Shanghai-based research firm Z-Ben Advisors, believes CIC should consider investing more in Europe than in the U.S. “The governments of the United Kingdom and the European Union are far more open to China investing as a passive investor in direct deals — in infrastructure, for instance,” he says. “Diplomatically, the governments of the U.K. and EU get along well with China and welcome investments from Chinese state-owned enterprises.”

Ironically, the drive for better returns may be forcing CIC to turn to its domestic market. In September 2015, CIC and several other partners — including Capital International, an arm of the Los Angeles fund group, and Ping An Ventures, a unit of the Chinese insurer — invested $3 billion in Didi Chuxing, China’s dominant ride-hailing app, to help finance its competition with U.S. rival Uber Technologies. Didi prevailed this summer when it bought Uber’s Chinese operations and agreed to invest $1 billion in the San Francisco–based company. The deal, combined with a separate fundraising by Didi, valued the company at about $36 billion. CIC also joined a group of leading Chinese financial companies, including China Construction Bank, that invested $3.1 billion in Ant Financial Services in April. That Alibaba affiliate is now valued at some $60 billion.

For a sovereign fund that was created to diversify China’s foreign exchange reserves through offshore investment, it seems odd to invest in some of the rising stars of the country’s Internet economy — companies that face little difficulty in raising capital. But Ding says he sees nothing problematic about investing in Chinese companies or their offshore vehicles.

Earlier this year CIC teamed up with KKR & Co. and Baring Private Equity Asia to bid for the Chinese businesses of Yum! Brands, the operator of KFC and Pizza Hut restaurants. The bid reportedly valued the businesses at $8 billion, but the consortium withdrew its offer in May, reportedly because of pressure on profits at the operations.

These deals suggest CIC is “chasing Chinese assets at the expense of global assets,” a trend that is likely to intensify in the future, says Orient Capital’s Collier. “Though I have not seen a lot of evidence of that so far, my understanding is they have been under a lot of pressure to increase returns, and investing in China-related deals may be one of the strategies.”

Ding is also looking to have CIC play a role in China’s big regional initiative, Belt and Road. This program, formerly known as One Belt, One Road, seeks to develop infrastructure links connecting China with countries from Southeast Asia to Central Asia to the Middle East and Eastern Europe. Two years ago the government launched the $40 billion Silk Road Fund to help finance some of these projects, but it is looking for other support.

“Belt and Road definitely will give Chinese enterprises many opportunities,” says Ding. CIC will look for chances to invest as well, he adds. The Chinese government regularly updates the chairman and his team on potential opportunities, he explains, “but we will only invest if we believe we will get returns from Belt and Road projects.”

Since its founding CIC has been handed “multiple and arguably conflicting missions,” says the Council on Foreign Relations’ Setser. Managing the equity of government holdings in major banks, supporting China’s strategic initiatives on outward-bound investments and seeking to increase the returns on China’s reserves by investing in riskier and less liquid assets are complicated challenges not usually found in a single entity. “These different missions have at times created tension, in my view,” Setser says. “Relative to the expectations at the time of its founding, the CIC has expanded its international investments a bit more slowly than many expected — in part, I suspect, because of competition with other parts of China’s government to manage China’s external portfolio.” That is a not-so-subtle reference to the State Administration of Foreign Exchange, a People’s Bank of China arm that oversees the central bank’s $3.2 trillion in foreign exchange reserves and also runs a $474 billion international investment portfolio out of Hong Kong.

Managing rivalries between major state institutions is part of the job of any top official, of course, and Ding’s impressive rise suggests he can more than look out for CIC’s interests. Generating strong returns is another matter. Ding may have great clout inside Beijing’s inner circles, but he faces the same challenges as other investors. Today’s low-return environment is the real sovereign. •

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