Asian sovereign funds learn tough lessons

December 7, 2009
Singapore Democrats

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The Wall Street Journal

The financial crisis taught most of the investing world a lesson about managing risk. Asia’s sovereign-wealth funds appear to be taking some lessons from bad investments to heart.

After the initial embarrassment of heavy losses on investments in Wall Street, state-owned investors in China and Singapore are reshaping their strategies by diversifying their investment scope and focusing on markets where they have better knowledge. They are also attracting talent more willing to consider jobs at these funds, although all efforts in this direction haven’t been successes. These two countries’ funds are Asia’s largest, and Singapore’s funds are viewed as models by other countries, making them essential to understanding how other Asian sovereign funds from South Korea and Malaysia will reshape themselves.

“For many sovereign-wealth funds, this is their first brush with difficulty,” Howard Marks, chairman of alternative-investment firm Oaktree Capital, said in a recent interview in Hong Kong.

“I imagine they will tighten up their practices and will start to look at investments as something other than just the chance to make money,” Mr. Marks said. “It’s also a chance to lose money or get stuck in an unattractive vehicle.”

China Investment Corp. learned the earliest lesson by investing $3 billion in Blackstone Group LP in May 2007 ahead of the private-equity firm’s initial public offering. CIC didn’t even have an official name when the deal was announced and had no internal structure in place to evaluate the deal. But CIC thought it saw a rare opportunity. In China, pre-IPO investing had been a profitable strategy for global private-equity funds and hedge funds. So, CIC executives thought, why can’t we do the same thing?

They soon learned that pre-IPO deals aren’t always winners: U.S. financial stocks, including Blackstone, took a dramatic turn downward. Still, people who work closely with the Chinese sovereign fund say criticism of that investment within China could have been a blessing in disguise for CIC’s longer-term success.

Rather than cutting new deals, CIC’s management spent most of 2008 focused on recruiting staff and picking up advice from investment-industry luminaries courting the fund as markets spiraled downward. CIC also built out a multiple-asset-class strategy to deploy its cash. CIC may not have a perfect system, but it is improved.

Meanwhile, CIC has brought in new talent, including Bill Lu, a former executive at U.S. hedge fund Tudor Investment Corp. recently recruited to help run CIC’s hedge-fund program. Good talent wasn’t available in the heady markets of 2007 when CIC was initially set up to manage a $200 billion chunk of China’s foreign-exchange reserves. Now, more Chinese financiers are willing to take jobs with CIC because it gives them an opportunity to manage a vast portfolio, and because many U.S. hedge funds have lost both the luster of their brands and their ability to pay large salaries to staff.

A stronger investing team and better structure has positioned CIC to be perhaps the most aggressive investor in the world this year. CIC has deployed cash at a rapid clip, putting at least $40 billion this year into deals linked to cyclical businesses, particularly commodities. It is also putting money into Chinese companies and backing global hedge funds and private-equity firms at a time when many of those firms are cash-starved and willing to offer attractive terms to new investors.

Oaktree’s Mr. Marks is one such beneficiary. His firm has received a roughly $1 billion commitment from CIC to manage, according to people familiar with the situation. Many question whether CIC is doing enough due diligence to wisely invest all that money, but most observers agree its timing and investment focus is smart.

Singapore’s state-owned investors, Temasek Holdings Pte. Ltd. and Government of Singapore Investment Corp., are taking in lessons of their own. Temasek has brought in more non-Singaporean professionals to improve its global savvy, refocused on markets it knows best in Asia, and begun a shift to a multiple-strategy-investing approach. GIC, the city-state’s biggest fund, also shook up its leadership, although it has been far less bold in bringing in outsiders.

Temasek made perhaps the boldest move in the aftermath of its sour bets on Barclays PLC and Merrill Lynch, though one that ultimately didn’t work out. It hired former BHP Billiton Chief Executive Charles “Chip” Goodyear to succeed Ho Ching, the wife of Singapore’s prime minister, as Temasek’s top boss and provide fresh blood to an organization whose management and board are dominated by Singaporeans. Mr. Goodyear, an American with more experience in commodities than the finance industry, ended up parting ways with Temasek during his transition over disagreements on strategy, suggesting that change at the fund will have to come more incrementally.

Still, Temasek has made some smart moves. It has refocused on Asian markets, making profitable investments in many of its portfolio companies’ rights issues and stepping up its bets on China’s state banks when many Western strategic partners sold out near the bottom of global markets to raise cash.

Temasek, which considers itself a state-owned investment firm rather than a sovereign-wealth fund, has also looked at diversifying its investment scope. It has traditionally stuck to equity investments and private-equity-fund commitments. Now it is looking more at debt investments and debt-fund commitments. It is also working on a plan, dubbed “Sea Town” internally, to create a co-investment vehicle with public investors. Those shifts will all make Temasek’s portfolio less closely linked to the gyrations of public-equity markets and the firm a more diversified alternative asset manager.

One question remains: can sovereign funds institutionalize these lessons? Hints of a global recovery make it tempting to revert to the old status quo. Sovereign funds will need to keep their humility and stay within their circle of competence—deals where they have an advantage other than their big balance sheets. That includes a better vantage point than most investors to see where Asia’s resilient growth will create winners with sustainable profits. They also need to steer clear of trophy assets that offer more personal rewards than financial.

As Oaktree’s Mr. Marks puts it: Sovereign-wealth funds are becoming wiser about their approach to investing, “at least until people forget the lessons of the cycle.”

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