A tale of two countries

The biggest pension fund in the US likes China. How does the hype compare to the risk? By Aaron Lovell

“It was the best of times, it was the worst of times.” Charles Dickens started his novel A Tale of Two Cities with what is now one of the most recognizable opening lines in English literature. While far removed from the London and Paris of Dickens, the best/worst dichotomy could be applied to modern-day China, a country that is seeing unbridled enthusiasm from investors, but which still faces numerous questions.

The California Public Employees' Retirement System (CalPERS), the largest US pension fund and a savvy investor in alternative assets, has been reevaluating its relationship with China, recently sending a group of trustees and executives to the country for a 12-day tour of its major cities. Technically, CalPERS is not yet investing in China, but last spring the pension began allowing its real estate division to make up to $650 million (€531 million) in bets on countries that are not on its permissive equity market list, including China. It is also indirectly involved in the country through its numerous private equity affiliations. There could be more direct involvement in the near future: former CalPERS chief investments officer Mark Anson has said he anticipates China to be added to the permissive list when the revised version is released this month.

There's no secret why institutional investors like CalPERS are increasingly salivating at the thought of China's real estate markets. Demographically, the China story couldn't get any better, with a population of more than 1.3 billion people and a country-wide migration from the disproportionately poor rural areas to the jobs and economic growth of cities like Shanghai, Beijing and Guangzhou. Things are going so well that, last month, the government announced that it had underreported its gross domestic product by $250 billion, leading some economists to predict that China could be the world's largest economy by 2030. And there have been plenty of reports about the thousands of buildings sprouting up—seemingly overnight—in Chinese cities as homeownership and personal wealth increases. It seems to be, as former Sex Pistols manager Malcolm McLaren once put it, a chance to make cash from chaos.

Investors are also encouraged because deals are finally starting to get done. Groups based in the region, like Singaporean real estate investment group CapitaLand and Australia's Macquarie Bank, have been at the front of the pack in terms of getting property vehicles up and running. Institutional investors from the West have also made in-roads into the region, particularly in trophy Shanghai office buildings. And private equity funds and property investors alike have found value in real estate development companies serving the burgeoning middle class.

Still, for all the breathless talk and wanton optimism about China, there haven't been that many transactions. And there is plenty of confusion surrounding the country's investment environment, raising an important question for institutional investors: how do you respond to the groundswell in enthusiasm for the region, while keeping in mind the fears about legal frameworks, regulation and rampant corruption? California State Treasurer and CalPERS trustee Phil Angelides told the Sacramento Bee of his reservations: “Can we insure that we can invest in a way that doesn't expose our pension funds to undue risk? The last time I looked, shareholders do not have any rights to protect themselves in China. I have serious reservations about whether our money can be invested in a way that makes sense for California taxpayers.”

Angelides, of course, does not mention China's ongoing human rights abuses and an abysmal environmental record. Last December, for example, authorities opened fire on demonstrators in a fishing village near Hong Kong protesting the fact that a government-owned power plant repatriated tracts of farmland; depending on who you believe, between three and 20 people were shot. Some estimates put the number of protests in the country at 200 per day (but to be fair, most do not end in bloodshed).

And there are other cracks which could give a US or European institutional investor pause. Despite explosive growth in the urban centers, vast stretches of countryside remain impoverished. Journalists continue to be jailed, sometimes for reporting on the country's economy, and the government continues to pressure companies, including Microsoft, in its ongoing attempts to censor its critics. A recent piece in London's Guardian newspaper points out that the nighttime view from the bar at the top of the Jin Mao Tower is often obscured by thick pollution generated by the teeming metropolis. It is part of the same pollution problem—known as the “brown cloud”—that occasionally drifts across the Pacific Ocean, far enough to touch the coast of CalPERS' home state.