China lost billions buying stocks just before crash

China Lost Billions in Diversity Drive

By Jamil Anderlini
Financial Times, London
Sunday, March 15, 2009

http://www.ft.com/cms/s/0/11fa4136-119f-11de-87b1-0000779fd2ac.html

BEIJING -- China has lost tens of billions of dollars of its foreign exchange reserves through a poorly timed diversification into global equities just before world markets collapsed last year.

The State Administration of Foreign Exchange, the opaque manager of nearly $2,000 billion of reserves, started making huge bets on global stocks early in 2007 and continued this strategy at least until the collapse of the US mortgage finance providers Freddie Mac and Fannie Mae in July 2008, according to analysts and people familiar with SAFE's operations.

By that point SAFE had moved well over 15 per cent of the country's $1,800 billion reserves into riskier assets, including equities and corporate bonds, according to people familiar with its strategy.

SAFE never discloses its holdings except to the top Chinese leadership, so it is impossible to know exactly how much it has lost from diversifying before markets crashed.

But judging from the subsequent fall in global stock prices and a conservative estimate that Safe held about $160 billion worth of overseas equities, Chinese losses on those investments would exceed $80 billion, or more than 50 per cent, according to Brad Setser, an economist at the Council on Foreign Relations in New York.

Total holdings of US equities by all Chinese entities reached $100 billion by the end of June last year, more than triple the total of Chinese holdings in June 2007, according to an annual survey published by the US Treasury.

In mid-2006 Chinese holdings of US equities totalled just $4 billion. Chinese investors are mostly barred from investing abroad and Safe is the only entity with the resources and the authority to make such large-scale offshore portfolio investments.

"SAFE has built up one of the largest US equity portfolios of any foreign government entity investing abroad, including the major sovereign wealth funds," Mr Setser said.

"It appears SAFE began diversifying into equities early in 2007 and, rather than being deterred by the subprime crisis, it continued to buy."

China's leadership has not commented on the equity losses but Wen Jiabao, prime minister, expressed concern about the value of China's large holdings of US assets on Friday and warned the US to take measures to guarantee its "good credit."

SAFE uses a Hong Kong subsidiary when investing in offshore equities in the US and other countries, including the UK, where this subsidiary took small stakes last year in dozens of UK companies, including Rio Tinto, Royal Dutch Shell, BP, Barclays, Tesco, and RBS.

As part of its diversification in early 2008, SAFE also gave some money to private equity firms such as TPG and to hedge funds on a managed account basis.

This gave the Chinese government ultimate approval for how its money was invested, according to people who have worked with SAFE.

The large shift into global equities appears to have started at around the time that Beijing approved the establishment of China Investment Corp., the country's official sovereign wealth fund, which has been widely criticised in China for incurring paper losses of around $4 billion on high-profile investments in Morgan Stanley and Blackstone.

The bulk of SAFE's holdings remain in US Treasury bills and much of the loss on its riskier assets will be offset by gains on long-term bills, according to Mr Setser.

"They are a lot more cautious and risk-averse now and have basically returned to buying government bonds," said someone who works with SAFE.

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