China’s SSF – defence making way for attack with investments

China is the world’s biggest new frontier since wild-west America in the mid 19th century. For instance, it controls four of the top 10 sovereign wealth funds by size, as just one of many examples of its nascent power. And China is changing, becoming much more of a global corporate citizen and less of the world’s factory. Or at least it’s trying to. Exemplifying this change is the evolution of one of China’s sovereign funds, the National Social Security Fund, which turns 10 years old this year. Greg Bright puts the fund into perspective.

China’s National Social Security Fund (SSF), which was set up in 2001 to aid the gradual privatisation of state-owned businesses as well as pick up the old-age insurance obligations of the time, is set to pass the 1 trillion yuan mark ($146.48 billion) by the end of this year.

Dai Xianglong, the chairman of the governing National Council (of the SSF) and chief executive, said recently that the SSF had grown by 38 per cent in 2009, to 776.5 billion yuan ($113.74 billion), following its only year of negative performance (minus 6.7 per cent on investment returns) the previous year, and would pass 1 trillion yuan later this year.

The fund has always adopted a defensive attitude to asset allocation. At the end of last year it was still about 40 per cent invested in fixed interest, although this had been dramatically reduced from 53 per cent a year earlier. Equities – both domestic and international – were increased from 22 per cent to 32.5 per cent at the same time.

China’s vice premier, Zhang Dejiang – it’s the sort of fund that politicians have a strong say over – said in March that the (unrevealed amount) foreign equity investments for the SSF achieved a 53.3 per cent return during 2009.

The fund’s long-term return has been stellar, if you just look at the surface. In the five years to 2007, the average annual return was 10.7 per cent. After 2008’s small negative (compared with large negatives for most other sovereign and pension funds), the fund returned more than 16 per cent in 2009.

However, when you look at any figures to do with China, you have to put them into context. The context is that China represents about 20 per cent of the world’s population – about 1.2 billion people. The context also is that China represents the world’s oldest civilisation, alongside the Greeks, with numerous major contributions to mankind which have inexorably seeped into its culture. The context is also that more than 100 million Chinese still live below the poverty line. And while the world’s growth engine is likely to pick up the pace even further this year, there are all sorts of social question marks over how sustainable this is.

So, even though the SSF returned 10.7 per cent in the five years to 2007, the domestic inflation rate was 8.1 per cent during the same period, leaving a modest gain over liabilities growth.

And while the first healthcare package came into being last year, covering more than 80 per cent of the population, it amounted to coverage of less than $100 per person per year.

The SSF does not reveal precise asset allocation numbers nor who its service providers are. It is known, however, that the fund is advised by several international asset consultants and is staffed by several hundred investment professionals, some of them seconded from its external managers. Its latest annual report, for 2008, says that it invests in a full range of financial assets and direct investments. The 2009 report is due in the next few weeks.

Dai confirmed earlier this year that the SSF was on track to invest up to 10 per cent of its assets in private equity. Due diligence was being conducted on three private equity firms.

However, much of the SSF’s funding has come from the transfer of shares in state-owned companies, which has provided a de facto private equity or direct investment exposure in the past.

From China’s point of view, the SSF is primarily a supplement to bigger efforts to provide for a social security support program for the nation in the future. The other three sovereign funds are the more glamorous China Investment Corporation (about $288 billion), the SAFE Investment Company (about $350 billion according to a “best guess” by the US Sovereign Wealth Fund Institute) and the Hong Kong Monetary Authority Investment Portfolio (about $140 billion).

China has, for instance, the world’s largest stock of foreign exchange reserves by a wide margin.

According to the Sovereign Wealth Fund Institute, China had $2.13 trillion in foreign exchange reserves as at June 2009, compared with the world’s total reserves of $7.5 trillion. Next was Japan, with $1.04 trillion, followed by Russia, with $435 billion. The US was ranked 21st in the world with $69.7 billion.

In a speech to an investment conference in Beijing in March, one of the Chinese Government’s most senior economic advisers, Li Yang of the Chinese Academy of Social Sciences, pointed out that this year marked the start of a proposed restructure of the Chinese economy, whereby there would be a greater focus on domestic consumption rather than exports in the future.

Investment, including foreign investment, would continue to be very important, however, for some years, he said.

Li also pointed out the many challenges due to urbanisation, such as the increasing demand for health care, education and other social infrastructure requirements.

The trend in China generally is for a more open society, notwithstanding the occasional high-profile human rights violations, with greater foreign investment and more say in world politics.

The country’s sovereign funds are also trending towards greater openness in their dealings with the western world, although they have a way to go to match the best of the big sovereign funds.

The Sovereign Wealth Fund Institute gives China’s SSF a rating of five out of 10 for transparency, according to its “Linaburg-Maduell Transparency Index”. The China Investment Corporation is rated a six, and the HK Monetary Authority an eight. SAFE, as might be expected, is given a two.