SPECIAL REPORT: China’s ‘O’ word

If there is one word that accurately sums up what the real estate division of the China Investment Corporation (CIC) is looking for from its investments, that word is optionality.

Indeed, you don’t need to speak to CIC’s real estate head Collin Lau for long before realising that the sovereign wealth fund is placing deals that inherit it additional but optional investment opportunities atop of its wish list. Lau told PERE: “For me, the optionality of having good long-term equity multiples is more important than capturing short-term IRRs.” 

Lau’s ethos has led one of the world’s most widely coveted institutional investors to investments that include the recapitalisations of Sydney-based industrial giant Goodman Group, Canary Wharf landlord Songbird Estates and US mall REIT General Growth Properties (GGP). That last one comes through its investment in the world’s biggest club fund, Brookfield Asset Management’s $5.5 billion Real Estate Turnaround Consortium.
Given those examples, it would be fair to say that, since its inception in September 2007 as a state-owned entity charged with investing China’s plentiful foreign reserves, CIC’s real estate investment programme has veered towards large outlays via various direct channels. As global real estate markets rebound, however, such deals – described by one PERE source as “low-hanging fruit” afforded by the carnage inflicted by the global financial crisis – are now less readily available.

As such, the Beijing-based sovereign wealth fund is evolving its investment strategy to take in a wider mix of joint ventures, club deals and commingled funds. Lau, who joined in February 2009 from New York-based financial services and investment firm Starr International, says CIC is working towards shifting its real estate portfolio towards a more even keel between direct and indirect investments.

In addition to writing mega-cheques for club deals or undertaking giant recapitalisations, CIC now wants exposure to smaller deals as well and, of great interest to PERE’s GP readers, it will be using more managers to do so.

This should be welcome news to a GP universe that has seen somewhat limited capital from the relatively new but nonetheless immensely powerful investor, which is able to induce GPs to “flock to their table” as one China-focused GP put it. Still, Lau and his team see more than 15 deals per week on average, another source close to the sovereign wealth fund says, pointing to the difficulty of pitching to the Chinese state investor.

Managers welcome

That said, Lau says CIC wants to work with multiple investment managers going forward, despite veering more towards direct investment in its early years. “I would like to extend a message that we will be handing out more mandates in 2011 and that managers are welcome so long as they are able to customise to fit our requirements,” he states. The caveat? “The flock,” as the GP termed it, must absorb CIC’s ‘O’ word readily if it is to attract CIC’s capital.

I would like to extend a message that we will be handing out more mandates in 2011 and that managers are welcome so long as they are able to customise to fit our requirements
Collin Lau, CIC

Goodwin Gaw, who founded Hong Kong-based Gaw Capital Partners, is one source of investment advice for CIC, having shared his market knowledge of the US and China with the sovereign wealth fund over recent years. He believes that, given CIC’s tendency to push for “dominant” positions on all of its investments, it is best suited as an anchor investor in a large transaction, in a co-investment capacity or through a separate account strategy over participating in commingled funds, which he says would be difficult for a GP to manage.

Still, Lau says the door is open to these vehicles “so long as we see no other way of doing any another structure with that manager.” He reiterates: “We like managers who are trying to be customer orientated.”
While commingled efforts are not off the table, blind pool commitments essentially are. Another GP familiar with CIC says the sovereign wealth fund requires physical deal pipelines from the start and wants to be offered more governance and control over the exit of assets before committing capital to managers.

That said, some commingled fund managers have received discretionary commitments from CIC including New York-based Morgan Stanley Real Estate Investing (MSREI), which was granted an $800 million commitment for its seventh global opportunity fund in 2008. Another example is Aetos Capital, which received a commitment of $250 million in 2010 for its Aetos Capital Asia IV Strategic Partners, a Japan- and China-focused fund.

Kenny Tse, head of Aetos’ China business, says the commitment to his firm was CIC’s first to a commingled fund in Asia. He hopes it is the start of a long-standing relationship with the sovereign wealth fund and is optimistic the fund’s early investments into a joint venture in Dalian and in distressed acquisitions in Tokyo office and residential assets will help that to materialise.

Tse says CIC is an investor keen on and able to maintain very regular contact with its managers. “We have monthly meetings, but we also talk regularly during the month on anything of common interest,” he notes. “One of the things I admire and appreciate about our partnership with CIC is that they treat us like long-term partners.”
However, Tse recalls that the partnership took hard work to form. Aetos’ capital commitment came after nine months of “intense” due diligence, during which CIC hired two third-party consultants to vet the firm, its executives and its strategy. He suggests that future GPs able to get CIC interested would likely undergo a similar examination.

The continuous scrutiny CIC places on its managers does not negate its recognition that managers need to be appropriately incentivised and that other LPs’ positions must be respected. “We have a fiduciary responsibility to other investors [that we invest with] in a fund,” Lau says. “For the couple of times we’ve done it, we’ve been clear with the investors that the exit must be determined by the fund.”
Such words will no doubt be heartening for fund managers, which have shorter investment horizons by definition.

Size doesn’t (always) matter

According to PERE’s sources, typical mandates from CIC are usually north of $100 million each. But CIC also is understood to be evaluating how to execute on smaller deals that would normally pass under its radar without the use of third-party managers. Indeed, CIC is understood to be trying to find creative ways to address such deals and “bundle” them together.

Partly because I am Chinese, I feel I have an obligation. If I can contribute in any form, I’m happy to do so. It’s an honour for me
Goodwin Gaw, Gaw Capital Partners

CIC’s returns in real estates are not publicly known, but market sources say it has achieved “very high double-digit” IRRs for the last two and a half years.  While this arguably could reflect opportunistic returns partially afforded by market distress overhanging from the last cycle, CIC is keen on creating a long-term recurring income stream of high-quality assets as well. In other words, the sovereign wealth fund will have a more core focus going forward, although opportunity funds will have a place within its strategy.

Whether core or opportunistic, Gaw says CIC gives the impression of being more interested in “capable” managers than those with big brands. “Many global institutions go for the big names as they perceive they offer security,” he says. “CIC is not in that camp. It is willing and able to make its own judgement.”

To help meet its various goals, CIC is making efforts to deepen its approximately six-strong real estate bench, although the sovereign wealth fund gains much intelligence from its industry peers. Gaw admits that, as a compatriot of CIC, he feels duty-bound to help the fund, even though there currently is no commercial connection between Gaw Capital and the sovereign wealth fund. “Partly because I am Chinese, I feel I have an obligation,” he says. “If I can contribute in any form, I’m happy to do so. It’s an honour for me.”
Other Chinese industry professionals feel likewise. Tse adds: “It is a real advantage to have a Chinese team and an office in Beijing. It clearly helps cement our relationship.”

Headline deals

CIC might be looking to diversify its investment strategy further, but its limited past is steeped in headline-grabbing investments, some of which acutely display Lau’s optionality mantra.

One good example is its A$500 million (€366 million; $508 million) recapitalisation of Goodman Group in August 2009. The Sydney-based logistics/business park developer and fund manager suffered heavy losses and write-downs after undertaking a large and expensive expansion into Europe at the height of the market. This opened the door for CIC to make its investment through hybrid securities and future options, which would make it the largest external shareholder with 18.2 percent of the company if converted.

Greg Goodman, chief executive officer of Goodman Group, told the South China Morning Post at the time: “CIC helped us with our recapitalisation. With its investment, CIC has a share of Goodman’s European and Australian projects.” In addition to providing exposure to a company with A$16.2 billion in assets under management, CIC’s investment in Goodman provided the option to participate in new acquisitions – one that it exercised in December.

Teaming up with the Canada Pension Plan Investment Board (CPPIB) and Netherlands-based Algemene Pensioen Groep (APG), CIC was part of the A$2.5 billion purchase of the ING Industrial Fund,  a 60-asset Australia and Europe logistics investment fund managed by ING Real Estate Investment Management. That deal, in which CIC has a 12.4 percent stake, was completed at the end of April.

“We want clubs of like-minded investors,” Lau says, echoing sentiments expressed by CPPIB, APG and others, such as the Abu Dhabi Investment Authority, in conversations with PERE over the past few years. Indeed, as if reading from a crib sheet circulated among the world’s largest investors, he adds: “An asset manager or operator and then two or three like-minded investors together – that’s a model growing in popularity.” 

Such collaborative efforts also are beneficial in terms of sharing best practices and market intelligence. “These [clubs] are good for helping each other in our respective home countries,” Lau says. “I could ask APG about Western Europe and reciprocally, if they are doing something in Asia, we could share our two-cent’s worth.”

APG, under the leadership of head of non-listed real estate for Asia Daan Van Aert, has approximately 75 percent of its Asia exposure in core markets such as Australia, Japan, Hong Kong and Singapore, but it is expected to increase its exposure to markets such as China, among others. In fact, APG invested in January in a Chinese development fund jointly sponsored by developer China Overseas Land & Investment and Industrial and Commercial Bank of China, in which CIC owns a 35 percent stake.

We want clubs of like-minded investors. An asset manager or operator and then two or three like-minded investors together – that’s a model growing in popularity
Collin Lau, CIC

Media attention also has focused on CIC’s investments stateside. On top of it’s investment in GGP (it acquired 7.6 percent of the REIT for its role in Brookfield’s Turnaround Consortium) and MSREI, US newspapers – in particular, the Wall Street Journal – have linked CIC to a string of high-profile capital outlays. In September 2009, the WSJ reported that CIC planned to invest in distressed situations stateside through schemes like the Treasury’s Public-Private Investment Program (PPIP), which was devised to help US lenders offload nonperforming loans by attracting investors with the promise of government-backed financing, although no transactions directly linking CIC to PPIP scheme investments have since surfaced. In January, however, the same newspaper reported that CIC had teamed up with AREA Real Estate Finance to buy an unspecified amount of preferred equity in 650 Madison Avenue, a single office property in New York.

Early outperformance

Outside of the real estate division, CIC has been criticised for the timing in its investments in Morgan Stanley, which began with a $5.6 billion purchase of a 9 percent stake in December 2007, and the June 2007 initial public offering of The Blackstone Group, in which it acquired an initial stake of less than 10 percent. While these pre-financial crisis forays have met with criticism, its real estate forays have enjoyed better timing and, by inference, better industry comments.

“Their timing has been perfect,” says another of Lau’s industry friends, Stanley Ching, who is head of real estate at CITIC Capital Group, the Hong Kong alternative investment business. “It’s amazing how much they’ve done with such a small team.”

Despite its financial heft, CIC’s real estate programme still is a fledgling operation, and conversations with GPs have all pointed to the division’s very lean headcount. Having executed primarily on direct deals to date, one could imagine the platform is pretty stretched.

Considering all of that, it’s hard to dispute CIC’s two wins in the 2010 Global PERE Awards earlier this year. Testament to its successes to date, the industry voted CIC as Asia LP of the Year and Lau as Asia Industry Figure of the Year, an accolade he remarks on humbly. “I really appreciate those votes,” he says. “I really didn’t expect that.  They should be attributed to the leadership of our top management and the diligence of the team.”

Most agree CIC’s limited history has heralded early success for the real estate division, even if it has come from being capital-rich enough to pick off some of the biggest direct transactions afforded by the global financial crisis – the “low-hanging fruit” as it was termed. Looking ahead, however, China’s preeminent international investment vehicle has recognised a need to take on a more mixed direct/indirect strategy. But with limited human resources, much depends on those managers positioning themselves to attract one of CIC’s highly sought-after cheques being able to demonstrate a solid understanding of the ‘O’ word.

A fledgling giant

Little is known about China’s preeminent international investment vehicle outside of what it publishes annually, but even that provides a decent context to working out what the sovereign wealth fund is all about
As might be expected of a large sovereign wealth fund, China Investment Corporation (CIC) is not an open book. It publishes an annual report, but it had not done so yet for 2010 as PERE went to press. Therefore, the most up-to-date resource is the 2009 report, which states that its assets under management stood at slightly more than €80 billion at the end of 2009.

Created by the Chinese government in 2007, CIC was charged with diversifying China’s foreign exchange holdings and obtaining higher risk-adjusted returns along the way. Of course, China’s currency reserves are massive. At its creation, CIC was granted 10 percent of the country’s then-$2 trillion reserves pile. According to the Financial Times, these reserves grew to $2.85 trillion in 2010, providing a hint of the scale of capital to come. As such, it would be fair to say that CIC is a fledgling organisation in terms of years in existence but a giant in terms of potential capital resources.

What is unclear to outsiders today is how the assets of CIC have expanded since the end of 2009. At the time, CIC had amassed an international portfolio of $81.1 billion, including its real estate investments. Therefore, it is difficult to state with much confidence how much of the initial $200 billion it has left to invest, assuming it has any.

A report by the Financial Times this January suggested that CIC indeed had deployed all its capital. However, the same newspaper said in April that an additional sum – potentially matching the first $200 billion – could be on the way.

What is known for certain is more detail about the structure of CIC. For example, it employs around 250 people – or at least, it did as of 2009. Out of those 250, those that the private equity real estate universe need to know are members of an approximately six-strong team led by Collin Lau, who joined in 2009 from New York-based Starr International, the long-standing global financial services and investment firm. They reside at CIC’s headquarters, which is located at New Poly Plaza in Beijing.

Lau, by dint of his responsibilities and no doubt at the behest of CIC’s most senior management, is not often in the public eye. However, he was able to speak to PERE in March in the wake of winning two of PERE’s prestigious Global PERE Awards, which recognised the international efforts of the sovereign wealth fund.