The China Investment Corporation (CIC) will entrust nearly US$80 billion of its US$200 billion assets to asset management firms to be selected via an open bidding process, the Economic Observer reported on June 30.

US$80 bln asset allocation plan

The asset allocation plan for the US$80 billion was designed by Morgan Stanley, one of the largest financial services firms in the world, anonymous sources told the newspaper.

The plan calls for US$70 billion of the total US$80 billion to be divided up into several investment segments – emerging market equities, U.S. equities, European bonds and so on. Each segment will be appointed to an asset manager, to be decided by open tender. CIC will hire a single institution to manage the remaining US$7 to US$10 billion, with a flexible investment strategy based on market trends.

Eyebrows have been raised by the fact that CIC, the second largest shareholder of Morgan Stanley, assigned the design of the assets allocation plan solely to that company.

An industry insider expressed his suspicion that Morgan Stanley might structure the plan to favor investment sectors that reflected its own expertise. The insider argued that, while it was legitimate for Morgan Stanley to be involved in the planning process, the CIC should have invited more than one investment bank to present plans.

Others are more sanguine. A senior manager of a foreign investment bank said the plan itself will not decide the outcome of the bidding, and since Morgan Stanley has abundant experience in optimizing asset allocation, it was logical for the CIC to choose them to draw up the plan. He added that openness and transparency in the bidding process is the most important factor. Apparently the CIC thinks the same. Not long ago, Zhao Haiying, director of research at CIC said that the sovereign wealth fund plans to enhance the transparency of its business operations.

Professional asset managers preferred

Based on Morgan Stanley's plan, as soon as the bidding ends, assets will be allocated to successful bidders for a prescribed time period. The capital allocated to each segment will remain relatively stable for at least two to three years.

All the major international fund managers have their eyes on the open bidding. The rules of the auction mean that each fund management firm can bid for two investment segments at most; according to unnamed sources, Goldman Sachs, UBS and Morgan Stanley have all put in bids for two segments. All the other firms on the bidding list are well known names from the world of asset management.

Although both international investment banks and professional asset management firms are actively participating in the bidding, CIC has shown a preference for the latter, unnamed sources told the Economic Observer.

Because investment banks conduct other businesses including consignment, consulting, bulk-commodity trading and so on, managing CIC funds may create conflicts of interest. Therefore, professional asset management firms with rich experience, and high, stable returns are being favored by CIC.

The contest between Goldman Sachs and Morgan Stanley

As the remaining US$7 to US$10 billion will be given to a single institution to operate, it has become the object of intense competition among the applicants, especially Goldman Sachs and Morgan Stanley.

According to the Economic Observer, Goldman Sachs has proposed a plan under which it and the CIC would set up a joint-venture to manage the investment. Its proposal is similar to the US$4 billion joint fund established by CIC and JC Flowers in March, in which CIC invested US$3.2 billion and JC Flowers US$0.8 billion.

Goldman Sachs is the No. 1 Wall Street investment bank, and its investment returns far surpass those of other investment banks. When the fact that it emerged relatively unscathed from the U.S. sub-prime crisis is factored in, Goldman Sachs' proposal appears very attractive.

Morgan Stanley has also put forward a competitive plan, based on its experience of managing the pension fund of the Teacher Retirement System of Texas (TRS).

According to Economic Observer, Morgan Stanley arranged for its TRS fund managers to present its plan to CIC representatives at a Morgan Stanley board meeting which CIC attended as a major shareholder.

Many other asset management institutions are reported to have presented plans to CIC.

The question of CIC's assets allocation

If verified, the US$80 billion bid will pose a question regarding the allocation of assets to CIC.

As a wholly-owned subsidiary of CIC, the Central Huijin Investment Company has already allocated more than US$125 billion of CIC's registered capital, including a total injection of US$80 million into the Bank of China, the Industrial and Commercial Bank of China, the China Construction Bank and China Development Bank, US$5 billion invested in China Everbright Bank and several securities companies, and it will shortly inject US$40 billion into the Agricultural Bank of China. CIC itself has invested US$3 billion in Blackstone, US$5 billion in Morgan Stanley, and US$3.2 billion in the joint-venture established with JC Flowers. That leaves only US$60 billion for discretionary investment, a US$20 billion shortfall from the US$80 billion asset allocation plan.

"There are only two possibilities. Either CIC will get more foreign exchange reserves from the government, or it will modify its plan to invest in the Agricultural Bank of China," a financial expert told the newspaper. "Either way it's a big deal to the market."

Background

CIC was founded on September 29, 2007 with the approval of the State Council, China's cabinet. It is responsible for managing a portion of China's massive foreign exchange reserves and has around US$200 billion of assets currently under management. Central Huijin Investment Company, the former state investment vehicle, was merged with CIC as a wholly-owned subsidiary.

(China.org.cn by Yan Pei, July 1, 2008)