November 8, 2009 9:01 am

Eyes stay focused on China’s SWFs

The latest data on China’s foreign reserves are likely to keep international fund managers focused on the business opportunities among the overseas investments of China’s sovereign wealth funds.

The data showed that the country’s foreign reserves increased by $141bn (£85bn, €95bn) in the third quarter to a staggering $2,273bn – over twice the level of three years ago. Since the financial crisis of the late 1990s, Asian authorities have been keen to accumulate foreign reserves as a safeguard against the effects of extreme capital flows, and China has been in the vanguard.

There has been much attention on how these reserves are invested and how changes in the reserves impact international exchange rates. This has become particularly pertinent at a time when there is wide speculation that the dollar’s position as the global reserve currency could be threatened if some of the large pools of reserves re-base their portfolios away from dollar denominated assets.

China accounts for 23 per cent of all foreign holdings of US Treasuries and is the largest single investor.

While the dollar’s decline this year has heightened speculation of its demise as a reserve currency, China has a vested interest in the dollar’s long-term stability. This was underlined earlier this year when Chinese Premier Wen Jiabao asked the US to maintain its good credit, honour its promises and guarantee the safety of China’s assets.

In mid-2005, China was applauded for shifting its exchange rate system away from a fixed peg to the dollar in favour of a link to a basket of world currencies.

At the time this was viewed as an important step towards financial and economic liberalisation and followed an intense period of lobbying by international governments. However, the policy was reversed last year, allowing China’s exports to stay competitive in the subsequent period of dollar weakness.

This has been an advantage for China relative to other Asian exporting countries that have of late seen their export prices rise in dollar terms. The expectation is for Asian currencies to continue their upward trend against the dollar despite some recent market intervention across the region by various central banks.

Ben Bernanke, the Federal Reserve chairman, recently highlighted the need for global imbalances to be corrected. In particular, he focused on Asia’s dependency on exports and the strategic priority to build up domestic consumption to erode the large trade deficits and surpluses that have accumulated as a result of the gaps between national saving, consumption and investment.

Certainly the mainland’s policy initiatives since the onset of the global financial crisis last year have been aimed at boosting domestic consumption and investment. Involving international firms in the management of the assets of its SWFs will have the added benefit of easing some of the tension.

A recent report published by FTSE entitled China’s Sovereign Wealth Funds, identifies four SWFs: the National Social Security Fund (NSSF) with Rmb600m (£53m, €59m, $88m); China Investment Corporation (CIC) with $200bn; State Administration for Foreign Exchange (Safe) with $347bn; and the China-Africa Development Fund (CadFund) with $1bn.

The report concludes that the NSSF has been the most successful to date in achieving investment returns, and that the pace of investing internationally by all SWFs has slowed as a result of the financial crisis.

The CIC’s latest investment into Morgan Stanley is seen as an indication that the wheels are beginning to turn and fund managers can expect more search activity. The NSSF is expected to resume its outsourcing programme, subject to approval by various ministries with an anticipated move into private equity.

In spite of the slower approach to outsourcing since the onset of the crisis the report is optimistic. Safe has perhaps been the most cautious according to the report, but the rate of reserve accumulation and the pace of economic growth in China is forecast to lead to the transfer of additional reserves to its SWFs and further overseas diversification.

As witnessed elsewhere in Asia, the allure of SWFs can attract international asset managers to the region and China’s growing importance economically is likely to prove a strong magnate for firms with regional aspirations.

Mark Konyn is chief executive of RCM Asia Pacific, an Allianz Global Investors company

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