Financial Funds -- Below the Radar

By Hugh Ashton

As China’s secretive investment fund makes waves around the world, how much longer can it keep quiet?

It’s no secret to learn Japan has been making large investments in China, especially in manufacturing. Less commented, however, is the flow of money the other way. For example, Japanese herbal pharmaceutical manufacturer Toa Seiyaku was purchased in August 2003 by Chinese firm Sanjiu medical and pharmaceutical, a comparative giant with a network of 10,000 retail outlets, guaranteeing a market for the smaller Japanese company’s products. Other Chinese acquisitions here have included specialist printer and machine tool manufacturers (Akiyama and Ikegai). China’s opaque state fund SAFE, with reserves of $1.5 trillion, is making stealth investments around the world.Here, acquisition of advanced production technology seems to be the main objective of the Chinese’s investment, and to avoid making too many waves here, the Chinese tend to target companies which are failing, or at least in trouble, rather than plundering crown jewels.

Role reversal
But although such acquisitions may have been rare in the past, the advent of a massive Chinese investment fund threatens to change this. The fund, SAFE, or the Chinese State Administration for Financial Exchange, moves under the auspices of the People’s Bank of China (PboC), the state central bank, and controls foreign money moving into and out of China.

Everyone “sort of knows” that the Chinese are holding enormous financial reserves, chiefly as a result of their massive trade surplus, but the way it works in practice is somewhat complex, and the scale is gargantuan. The Chinese yuan is linked to the US dollar (and has been since 1994), causing artificially high (up to 10 percent) growth in the Chinese economy almost every year since then. A large proportion of the resulting money has been poured back into the retooling and revamping of large monolithic former state enterprises, stimulating China’s productivity still further. Much of China’s current wealth is the result of exports on a large scale to the US, resulting in a flow of dollars (pegged to the yuan) across the Pacific.

Money under the mattress
Of course, China is not the only country exporting to the US and receiving dollars, but while most countries allow the exporting enterprises to do what they will with their hard-earned greenbacks, China’s central government demands that this foreign currency is remitted to the PboC, which in turn transmits the money to SAFE. The amount of foreign currency that has been piling up under SAFE’s mattress is staggering—as of September 2008, it came to nearly $2 trillion (Or put another way, a little under $7,000 for each man, woman and child in the US). Even more impressive is the growth of SAFE’s reserves—in January 2007, the value was a mere $1.5 trillion.

That’s an awful lot of dollars to be holding, especially right now when Wall Street is virtually closed for repair, and the dollar seems to be entering a state of free-fall. So, like any Japanese housewife sitting on a wad of yen tucked away at the back of the closet, SAFE is shopping around for investment opportunities as well as ways to diversify from the dollar; for example, by pegging the yuan to a basket of non-dollar currencies. China started moving towards a sell-off of some of its dollar holdings in July 2006 when it bumped the yuan against the dollar by about 2 percent.

SAFE around the world
But simple currency manipulation is not the only game in town when it comes to disposing of embarrassingly large dollar holdings. At the end of 2006, SAFE had already started direct foreign investment, to the tune of over $82 billion. In September 2008, it was reported that SAFE had invested $6.7 billion in just under 50 UK companies. These include household names, such as Cadbury, Unilever, Tesco, British Gas, etc., as well as a number of banks. None of these have been a snap decision—according to some of the companies in which investments have been made, they took place some time ago. Around the world, SAFE has also invested in energy, including France’s Total—the world’s fourth-largest oil company, taking a stake of between 1 percent and 2 percent, valued at some $2.8 billion. The investment has been apparently made with Total’s full knowledge.

Proxy investments
However, sovereign wealth funds (SWFs), such as China’s own China Investment Corporation (CIC) or SAFE itself, tend to attract attention, and hence China prefers to work through cut-out methods. According to a Tokyo-based financial advisor who wishes to remain anonymous, Chinese authorities have been sounding out the possibility of investing in funds through such advisors, not just in Japan, but worldwide.

By investments through funds, such as the recent $2.5 billion poured into America’s TPG fund in June 2008, the Chinese authorities hope to deflect the bad press that is often associated with SWFs, and also appear to be attempting to fly below the radar, keeping investments below the levels where disclosure of foreign interests is required. SAFE has also set up a special Hong Kong-based fund investment company of its own called TPG; a privately held company with SAFE administrators on its board. The TPG investment has an ironic footnote; TPG had previously placed $7 billion in the now-defunct Washington Mutual—a big mistake if ever there was one. Given a series of Chinese investment disasters: investments in US Treasuries, agency debt (Fannie Mae and Freddie Mac), Blackstone (where CIC is seemingly throwing good money after bad), and Morgan Stanley, one commentator was moved to write that he was going to set up his own hedge fund, whose guiding strategy would be to short anything that the Chinese were buying.

What about Japan?
But how does all this affect the Japanese economy? Although the financial sector is relatively sound, the economy is struggling with a credit crunch, especially where SMEs are concerned. J@pan Inchas learned that one of SAFE’s administrators visited Japan in the autumn of 2008 specifically to discuss investment opportunities. Whether these are direct investments in Japanese corporations, or whether they would be made through funds is still unclear, but it would seem that Chinese money would be welcome in the cash-strapped Japanese manufacturing sector. A total investment figure of $20 billion has been mentioned, which is substantially more than Total or TPG’s investments, and which sounds like a lot of money (and let’s face it, it is) until it is put in perspective as just over 1 percent of the investment capital available to SAFE. Still, this amount of money speaks volumes, and could well open doors that have remained locked to China until now, allowing Chinese foreign currency reserves to be set to work more efficiently, at the same time as facilitating access to Japanese expertise and technology.