Lou Suffers Blackstone#39;s #39;Fat Rabbits#39; in China Fund (Update1)
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Feb. 27 (Bloomberg) — When Lou Jiwei visited Switzerland
one spring weekend in 1993, the Chinese government economist was
so eager to see the inside of a Swiss bank that Credit Suisse
Group opened its Zurich head office on a Sunday to show him
around.
“He asked all kinds of questions, says William Wirth, the
Credit Suisse director who gave Lou a tour that included the
strong room. “And he wasnt just interested in financial matters.
He wanted to get a real helicopter view of the economy.
Lou also stopped at the homes of farmers in the village of
Weesen, an Alpine community with a population of 1,500 people and
3,000 cows. “He even looked inside the fridges and cupboards,
says Dean LeBaron, a Boston-based fund manager who owns a
vacation home in Weesen and hosted Lous visit. “He was very
inquisitive.
Today, investors, regulators and politicians are asking
questions about Lou, now chairman of China Investment Corp. a
sovereign wealth fund set up last year. Lou, 57, whos never been
a fund manager before, has about $200 billion in his care, $70
billion of which he will invest outside China.
His first investments for CIC have had mixed results so far.
He spent $3 billion in May for a 9 percent stake in Blackstone
Group LP, the worlds biggest buyout fund, which has since lost
almost half of its value. In December, he bet $5 billion for as
much as 9.9 percent of Morgan Stanley, the second-biggest U.S.
securities firm. As of Feb. 26, a 9.9 percent stake would have
been worth $4.91 billion.
`Fat Rabbit
In December, CIC invited Western fund managers to apply to
help Lou manage the remaining $62 billion he plans to invest
abroad. He has made trips to London and New York to meet
potential managers. In a speech in Washington in February, Lou
explained why CIC had bought the Morgan Stanley stake after the
Wall Street bank approached it seeking funds.
“If there is a big fat rabbit, we will shoot it, he said.
“Some people will say we were shot by Morgan Stanley, but who
knows.
Lous war chest makes CIC the fifth biggest of the sovereign
funds, investment pools that are playing a growing –and
controversial — role in global financial markets. The largest
fund, the Abu Dhabi Investment Authority, manages as much as $875
billion, more than four times the amount held by CIC, according
to data compiled by Bloomberg.
Transparency
These state-managed funds control $2.5 trillion in assets
worldwide, a figure that will climb to $12 trillion by 2015,
according to Morgan Stanleys global currency economist, Stephen
Jen. Since late last year, sovereign funds have spent $59 billion
investing in Wall Street and Asian banks, according to Bloomberg
data.
The downside of all this money is that sovereign funds can
lack transparency, follow political rather than commercial
agendas and destabilize markets with the sheer weight of their
investments, says Edwin Truman, a former assistant U.S. Treasury
secretary who testified in November before the Senate Committee
on Banking, Housing and Urban Affairs about sovereign wealth
funds. “They involve a dramatic increase in the role of
governments in the ownership and management of international
assets, he testified.
“This characteristic is unnerving and disquieting. It calls
into question our most basic assumptions about the structure and
functioning of our economies and the international financial
system.
Mountain of Reserves
Thanks to booming export industries and trade surpluses,
China has accumulated the worlds biggest mountain of potentially
investable foreign exchange reserves. On Dec. 31, the funds stood
at $1.53 trillion, about 50 percent more than Japans and 30
times the U.S. assets of $46.9 billion, according to Bloomberg
data.
How much of that $1.53 trillion will eventually be under
Lous command is an unanswered question. Until now, most of
Chinas reserves have been invested almost exclusively in U.S.
Treasury bills and other low-yielding dollar-denominated bonds,
says Brad Setser, a fellow at the New York-based Council of
Foreign Relations.
In March 2007, Chinas then finance minister, Jin Renqing,
announced that the government would create CIC to seek to
increase returns by diversifying into equities. The fund, which
was only formally created in September, reports directly to the
Cabinet.
One of CICs first actions in June was to buy Central Huijin
Investment Co., the government investment arm that holds
controlling stakes in Chinas three biggest banks, for $67
billion. CIC also paid $20 billion to recapitalize China
Development Bank, a fourth Chinese lender.
Bank Stakes
In turn, the Chinese banks have been acquiring stakes in
some of the worlds biggest financial institutions. In July,
China Development invested $3.04 billion for 3.1 percent of
Barclays Plc, the U.K.s third-largest bank.
And in October, Industrial %26amp; Commercial Bank of China, the
worlds biggest by market value, agreed to pay 36.7 billion rand
($5.5 billion) for 20 percent of Johannesburg-based Standard Bank
Group Ltd., Africas biggest lender. CIC and the Ministry of
Finance together control 70 percent of ICBC.
“Theres a very significant pool of foreign exchange in the
hands of various state bodies in China, most of which are owned
by CIC, Setser, 37, says.
Other Chinese state-controlled financial institutions have
also been buying foreign bank shares. In November, Ping An
Insurance (Group) Co., the countrys second-biggest insurer,
bought a 4.2 percent stake in Fortis Group, Belgiums biggest
financial company, for 1.81 billion euros ($2.7 billion).
`Havoc
And the State Administration of Foreign Exchange, or SAFE, a
unit of the central bank, has bought less than 1 percent of
Australia %26amp; New Zealand Banking Corp., the countrys third-
biggest lender.
Chinese investors could upset U.S. markets if they tried to
sell some of the $387 billion of U.S. Treasury bills they own,
Truman says in an interview. “They could cause havoc if they
decided to dump those Treasuries, he says.
China is unlikely to do that, he says, since such a move
would hurt the value of its other U.S. dollar assets. He says
hes more worried about the risk of a U.S. backlash against such
foreign investments and recommends that Treasury Secretary Hank
Paulson should be in contact with his Chinese counterparts.
“They dont just need a red telephone between the defense
departments, they need one into Mr. Paulsons office, Truman
says.
Backlash
The U.S. has shown signs of financial protectionism in the
recent past. In 2005, U.S. legislators blocked an $18.5 billion
bid for U.S. oil company Unocal Corp. by Chinas third-biggest
oil company, state-controlled Cnooc Ltd., on national security
grounds.
The following year, Dubais DP World was forced to sell six
terminals at U.S. ports it had acquired for the same reason.
President Nicolas Sarkozy of France, Chancellor Angela
Merkel of Germany and U.S. Democratic Party presidential
candidate Hillary Clinton have all voiced concerns about the
activities of sovereign funds. “Theyve got to be more
transparent, Clinton said on Jan. 15 during a debate in Las
Vegas.
The International Monetary Fund said in October that its
drafting a voluntary code of conduct it hopes will regulate
sovereign funds.
Lou and his senior executives declined to be interviewed for
this article.
Let John Mack Do His Job
In speeches and news conferences, Lou and Chinas leaders,
including Premier Wen Jiabao, have said that CIC will be
independent of its government masters, deciding which shares to
buy based on their profit potential.
“I need to make money, Lou said in Washington at a World
Bank meeting in February. “If I dont I cannot survive. So how
can I have political motives?
CIC will also be a passive investor. CEO John Mack is better
at running Morgan Stanley than CIC would be, Lou said. “So why
not let him do the job?
When it bought into Blackstone, CIC declined the buyout
firms offer of voting shares and didnt ask for a seat on the
board, said Stephen Schwarzman, the buyout funds chief executive
officer.
“Theyre not trying purposely to influence our
activities, Schwarzman said during a panel discussion at the
World Economic Forum in Davos, Switzerland, in January. “Our
experience with the sovereign wealth funds is that they are smart,
they are long-term, they are highly professional. All theyre
looking for is the highest rate of return with safety that they
can. In that sense, they are really a model type of investors.
Sources of Information
CICs Morgan Stanley stake is also nonvoting.
CICs stakes in Blackstone and Morgan Stanley have multiple
benefits for Lou, says LeBaron, 75. The American fund manager
first met Lou in Shanghai in 1991, where LeBaron was trying to
set up one of the first China equity funds.
“Hes buying into companies that will be sources of
information for him rather than just because banking stocks are
cheap, says LeBaron, who founded Batterymarch Financial
Management Inc. and later sold the fund manager to Baltimore-
based Legg Mason Inc. “He will be able to learn from Blackstone
and Morgan Stanley.
Lou, who spent eight years as a deputy finance minister
before joining CIC, currently relies for investment advice on two
lieutenants. President and Chief Investment Officer Gao Xiqing,
54, is a graduate of Durham, North Carolina-based Duke University
Law School who once worked on Wall Street for Richard Nixons old
law firm, Mudge, Rose, Guthrie, Alexander %26amp; Ferdon.
Temasek Model
Gao most recently was vice chairman of Chinas fledgling $26
billion national pension fund and also worked in Hong Kong at the
investment banking arm of Bank of China, the countrys third-
biggest lender. He also served as deputy chairman of the China
Securities Regulatory Commission.
Lous other senior aide is Vice President and Chief Risk
Officer Jesse Wang, 57, also chairman of China International
Capital Corp., the first Chinese-foreign investment bank, which
is 34 percent owned by Morgan Stanley.
The three men have to deliver the profits their political
masters demand. CIC is modeled after Singapores Temasek Holdings
Pte., which invests its $110 billion portfolio in companies
ranging from banks to port operators, to defense equipment
manufacturers, then Finance Minister Jin said when announcing
CICs creation in March 2007. Temaseks total shareholder returns
averaged 17 percent a year during the five years ended in March
2007, the Singapore company said in August.
Effect of Yuan
That compares with an average annual return of 4.12 percent
on U.S. Treasuries during the five years ended on Dec. 31. “We
will try to maximize the profits and returns on our management of
foreign exchange, Jin told a press conference at the time.
That wont be easy, Setser says. CICs profits have to pay
the interest, ranging from 4.3 to 4.69 percent, on local currency
bonds that were sold by the government to the central bank to
raise CICs investment funds.
And the funds foreign currency returns will be weaker when
they are converted into yuan, which the government has been
allowing to appreciate against the dollar.
In Washington, Lou disputed this analysis, saying that CIC
wouldnt be investing domestically, so its returns in yuan would
be irrelevant. “Our annual rate of return target is 5 percent,
he said. “Our long-term return target is a little bit higher
than this.
Bloggers Criticism
“Lou and Gao are in a pretty impossible situation, says
Nicholas Lardy, a China scholar at the Peter G. Peterson
Institute for International Economics, an independent Washington-
based research group. With global stock markets in turmoil after
the drop in the Blackstone investment, he says, “The timing
couldnt be worse.
Still, Lardy says, Gao proved his independence during his
stint at the China Securities Regulatory Commission. “He was
abrasive, impatient — he thought they were underperforming,
moving too slowly, says Lardy. “Hes not going to be an arm of
Chinese foreign policy.
Lou and Gao face criticism at home, especially after the
Blackstone investment. “Now we know what Lou Jiwei, Gao Xiqing
and other officials are up to — squandering taxpayers money
like its dirt, wrote one blogger who used the nom de plume He
Bi, Chinese for Why?, on Sina.com, the countrys biggest portal,
in August.
`Powerful Figure
CIC should stick to investing in China, says Liu Yang, who
helps manage $4.2 billion in Hong Kong for Atlantis Investment
Management. “Why are they running overseas? Liu says. “The
yuan is appreciating, and investors worldwide are diverting their
funds to China, seeking a haven for their investments. China has
so many enterprises which are flourishing.
Outside China, Lou is being wooed — partly because hell
likely have a free hand in choosing outside fund managers, says
Victor Shih, author of Factions and Finance in China (Cambridge
University Press, 2008).
“For the fund managers, he will be a very powerful figure
because he will determine their bonus paychecks, says Shih, a
political economist at Northwestern University in Evanston,
Illinois.
In December, the City of London threw a banquet in Lous
honor at the Mansion House, the Lord Mayors official residence.
Among the 60 guests: Stephen Green, chairman of HSBC Holdings Plc,
Europes biggest bank; Barclays Chairman Marcus Agius; Mark
Tucker, group CEO of Prudential Plc, Britains second-largest
insurer; and John Fraser, chairman of global asset management at
UBS AG, Switzerlands biggest bank.
Spokesmen for the banks declined to comment on whether their
firms are seeking to help CIC manage its funds. Prudential has
applied, says Hong Kong-based spokesman Chad Tendler.
Unwelcome
At the London dinner, Lord Mayor David Lewis proposed to Lou
that CIC open an office in London. Lewis says Lou told him that
such a move was under consideration.
“We would like to learn from you, Lou told the London
bankers. In Washington, Lou said some other European countries
had made him feel unwelcome and that he wouldnt invest in those
places.
In Japan, which Gao visited in February, financial services
minister Yoshimi Watanabe told reporters that CIC investments
would be welcomed.
Lou, a native of Yiwu, 200 kilometers (124 miles) southwest
of Shanghai, is used to learning on the run. Born in 1950, the
year after Mao Zedongs communists seized power, Lou was forced
to stop his schooling at age 16 when the chaos of the Cultural
Revolution enveloped China.
Cultural Revolution
University entrance exams were suspended for 12 years, and
most youths of Lous age were sent to the countryside to work.
Lou chose another option. In 1968, he joined the Peoples
Liberation Army. He was assigned to the navy and sent to Hainan,
a tropical island off Chinas southern coast, where he served
with the southern patrol fleet number 4009, according to a
biography supplied by Chinas state information center.
“We talked frankly about his time during the Cultural
Revolution, LeBaron recalls. “For him and other Chinese I know,
it was about trying to find a line between being a fanatic and
still surviving.
In 1973, Lou joined the Communist Party and moved to Beijing,
where he was a worker in the Shougang iron and steel works,
according to the official biography.
After the Cultural Revolution ended, China resumed
university entrance exams. The 1977 exam was one of the most
competitive ever held, says China-born Lawrence Lau, 64, emeritus
professor of economics at Stanford University and dean of Hong
Kongs Chinese University.
Econometrics
Almost 6 million students from 13 to 37 years old sat for
places, according to Education Ministry statistics. Fewer than 5
percent gained entry compared with 56 percent in 2007.
“People who took it had to have strong initiative, a strong
will to succeed, as well as an ability to teach themselves — a
great combination, says Lau. “It was a remarkable class.
Lou, then 27, won a spot at Tsinghua University, Chinas
equivalent of Massachusetts Institute of Technology, to study
computer engineering, according to the state information center.
On graduation in 1982, he switched to the China Academy of Social
Sciences, where he studied econometrics.
By then, Chinas paramount leader was Deng Xiaoping, who had
assumed power intent on transforming China into a booming market
economy. Since then, China has recorded an average 10 percent
annual growth.
In 1984, Lou joined the State Council Research Center, which
helps Chinas cabinet shape policy. Four years later, he moved to
Shanghai to become deputy director of the local state reform
commission, which put into practice new economic rules that would
transform the city into Chinas commercial and financial capital.
Returns in China
Shanghais mayor at the time was Zhu Rongji, later to become
governor of the central bank and, from 1998 to 2003, premier of
China. Lou became a Zhu protege, LeBaron says. “Working in the
Shanghai reform commission in those days was a license to be
liberal, he says.
LeBaron says he was introduced to Lou, who became his
government point man. “He was very helpful, allowing us to buy
securities in China at a time when securities laws had not been
properly implemented, LeBaron says. “Stock exchanges were open
but more for show than actual practice. Could we have done it
without him? Probably the answer is no.
LeBarons Equity Fund of China raised $30 million from
investors such as AT%26amp;T Inc. and General Motors Corp., according
to “Mao, Marx %26amp; the Market (John Wiley %26amp; Sons, 2002), the book
LeBaron wrote about his adventures investing in China and Russia.
By 1995, his Batterymarch managed $5.7 billion.
Trip to Europe
Legg Mason, which paid $120 million for the company, merged
the China fund into an emerging-markets fund in 1999. Today,
Batterymarchs mainland China investments are worth $728 million,
according to Legg Mason spokeswoman Maria Rosati.
In 1992, the government transferred Lou to Beijing to head
the state reform commission at the national level, according to
his biography.
The following year, together with a group of colleagues, he
traveled to Germany to study techniques to battle inflation,
LeBaron says. It was during that trip that Lou called LeBaron in
Switzerland and asked to visit for the weekend.
In 1995, the Chinese government dispatched Lou to Guizhou,
an impoverished southwestern province that then had only 100
kilometers of paved roads, to become deputy governor.
Lou threw himself into that challenge, says LeBaron, who
spent a weekend with him during that time. “He built a new
airport and roads, he says. “He was very enthusiastic.
Blackstone Deal
In 1998, Zhu Rongji, then premier, recalled Lou to Beijing
as deputy minister for finance, a position he held for the next
eight years. Then in March 2007, the new premier, Wen, promoted
Lou to the cabinet as deputy secretary of the State Council.
Three days later, the central bank announced he had been
appointed to head CIC.
“Getting so much money at the beginning was not because we
were ambitious, Lou said in Washington. “It was meant to
absorb excess liquidity. Ideally, I would have loved to have only
$2 billion at the beginning.
Lou and his team set up shop in gray-painted, low-ceilinged
temporary offices on the fifth floor of the Ping An building in
Beijings financial district, about a mile west of Tiananmen
Square. Even before CIC was officially established in September,
they had done their first big deal.
In January 2007, Blackstone appointed as its Asia chairman
Antony Leung, 56, a former banker with Citigroup and JPMorgan
Chase %26amp; Co. who from 2001 to 03 had served as Hong Kongs
finance secretary. Leung, whos married to Chinese Olympic diving
gold medalist Fu Mingxia, declined to be interviewed about his
role in the CIC deal.
`Kiss Up
Blackstone approached the Chinese government about investing
in its initial public offering, Jesse Wang, who acted as
spokesman for CIC, announced at the time. Instead, Lou and his
team decided to buy a stake pre-IPO at a 4.5 percent discount to
the IPO price.
“When you have that sort of money, a lot of people want to
kiss up to you, says Andy Xie, former chief economist in Asia
for Morgan Stanley and now a Shanghai-based independent economist.
“Someone shows up and gives you a discount. Blackstone was a hot
name.
Xie, 47, says Lou and CIC have learned to be more cautious.
In November, CIC announced it would invest 780 million Hong Kong
dollars ($100 million) in the Hong Kong IPO of China Railway
Group Ltd., the worlds third-biggest construction company. Since
the Dec. 6 share sale, China Railway stock has risen 61 percent
compared with a 20 percent decline in the benchmark Hang Seng
Index.
Moving Office
Then on Dec. 19, China Investment acquired as much as 9.9
percent of Morgan Stanley for $5 billion, making it the companys
second-largest shareholder after Boston-based State Street Corp.
CIC, advised by New York-based investment bank Lazard %26amp; Co., has
avoided the danger of the sort of paper losses it incurred with
Blackstone by buying securities that convert into Morgan Stanley
shares in 2010.
The units pay interest of 9 percent. “The Morgan Stanley
deal is reasonably good, Xie says. “The yield covers the cost
of capital. Since CICs purchase, Morgan Stanley stock has
fallen 6 percent.
This year, CIC is due to move to grander premises in the New
Beijing Poly Plaza, a 24-story tower designed by Chicago-based
architects Skidmore, Owings %26amp; Merrill.
The building, whose name translates as “Protecting the
Profit, boasts a 90-meter-tall (295-foot-tall) atrium enclosed
by what the architects claim to be the worlds largest cable-net-
supported glass wall. It also houses jade sculptures and a museum
exhibiting ancient bronze artifacts.
For Lou, the challenge now is to deliver returns as
impressive as his new headquarters.
To contact the reporters on this story:
William Mellor in Hong Kong at
