China Investment Corporation (CIC), the Chinese sovereign wealth fund, currently manages $332bn andlast year invested $58bn. It has been on accelerated path in learning about investing in hedge funds for the last three years. A source close to the CIC suggests that they are about to make their next commitment to a specific hedge fund.
The story of China Investment Corporation’s interest in alternatives can be traced back to the purchase of a USD 3 billion stake in alternative investment company Blackstone during its IPO in mid-2007. A predecessor entity to the then unformed CIC negotiated a non-voting stake with a four year lock-up. On day one of public trading this looked like a master stroke as Blackrock stock soared to $45 from the $31 (top-of-the-range) issue price. However that level has never been seen since and post-Credit Crunch the BX stock traded down to $4 and is now at just over $9.
The second leg of the advisory platform for CIC’s hedge fund program was the purchase of an interest in Morgan Stanley late in 2007. The Chinese SWF bought $5.6 billion of Morgan Stanley convertible securities with a conversion price of $48 to $57 in 2007. This was a 10% stake at the time. The CIC’s stake in MS was then diluted when, in October 2008, a major stake in the investment bank was bought by Mitsubishi UFJ. In the middle of last year CIC spent $1.2bn buying 44.7m shares of common stock in the bulge bracket investment firm to take its interest back to 9.86%.
So the CIC had two natural partners in looking to expand its investments beyond fixed interest and other additional assets. The intention from the off was to invest as much as $6bn within a year to hedge funds. The first step for CIC in investing in hedge funds was taken in July 2009 when allocations were made to the fund of hedge fund units of Blackrock and Morgan Stanley. Blackrock received an allocation of $500m to put into a portfolio of hedge funds, and Morgan Stanley some $200m.
Co-Opted Specialist Knowledge
At this point, at the start of the second half of 2009, the China Investment Corporation was utilising a knowledgeable special adviser to the chief investment officer of CIC. Felix Chee, the special advisor, had been responsible for an allocation of $1bn to hedge funds when he was working at the endowment of the University of Toronto. But this was several leagues different. The intention then and now is to build a core exposure to hedge funds for CIC with two elements – holdings in large, experienced single manager hedge funds and exposure to hedge funds via a small number of funds of hedge funds.
So having described the first funds of hedge funds exposures, what about the single manager exposures? Special advisor Chee has stated that CIC were to going to give capital to the best managers across a spectrum of investment strategies. The representatives of the Chinese SWF certainly started at the top: they invited Jim Simons of Renaissance Technologies to go to China to see if he was prepared to sell a chunk of his firm. He was not, and given his subsequent announcement that Simons will retire this year, it was only to be expected that the first single manager allocations went elsewhere. The first allocations came at the end of the 3Q last year and went to a natural extension of the fixed income investments already in place within the CIC, probably allowing some comfort that the strategies being used were ones that could be readily understood.
Unsurprisingly, the first two allocations of capital went to large, successful hedge fund management companies. The largest mandate to date has gone to a very large firm - Oaktree Capital Management is a Los Angeles based shop that manages US$76 billion in fixed-income strategies including distressed debt and high yield. The CIC has given Oaktree a $1bn mandate.
Oaktree espouses a clear investment philosophy based on six elements: the primacy of risk control (priority of preventing losses); an emphasis on consistent returns in the medium term to deliver a high batting average in the long term; Oaktree only invests in inefficient markets which may give a return to the manager’s skill and effort; specialisation of each investment portfolio is the surest route to the return targets; the investment process is entirely bottom up; the firm keep portfolios fully invested whenever attractively priced assets can be bought and do not time markets.
The second single manager hedge fund mandate granted by the China Investment Corporation was awarded at the end of last September to London’s Capula Investment Management. Reflecting the dynamism of the industry, Capula was set up only in 2005, and sold a chunk of the equity in the management company to the Petershill Fund (run by Goldman Sachs) in 2008. At the time of the capital allocation from CIC Capula ran between $3 ½ and 4 bn mostly in fixed income arbitrage. Capula presently advises on $4.6bn of assets. The returns of the main fund, Capula Global Relative Value Fund are very impressive – average annual returns of 13.3% with 88% of months positive. The volatility of the return series is only just under 3.5% and there has been no correlation to traded equity markets.
In-House Specialist Knowledge
After the first single manager hedge fund investments in the third quarter of 2009, the next significant development in the hedge fund activities of CIC came at the end of the year when there was an appointment to run the hedge fund investments on a permanent basis. Bill Lu, was born and educated in China, but received his post graduate education in the United States, and went on to manage the relationships in China of Paul Tudor Jones’ Tudor Investments. His background as a portfolio manager at Tudor, and experience at both end of the Sino-American axis make his credentials clear.
Lu is responsible for CIC’s investments in hedge funds and investments in securities which reflect hedge fund exposures in public markets. It is thought that after a couple of quarters bedding in, the first of Bill Lu’s major decisions is about to become publicly visible as the next single manager hedge fund mandate from CIC is made known.
The market scuttlebutt suggests that CIC will allocate capital to New York’s York Capital, an organisation running nearly $14bn in event driven strategies. James Dinan’s firm is known for using a catalyst-driven, fundamental value approach, which it applies to US, European and Asian developed market securities, including taking credit risk. Whilst the size of the allocation has not been confirmed, an allocation of $500bn would be proportionate to the other hedge fund investments of China Investment Corporation.
Two Additions from AR Magazine: 1) York Capital Ranked Number One Among Top 50 by Investors
2)York explains May losses
RANKED Number 1 in 2010
AR Magazine carries out an annual poll in which investors score hedge funds by various criteria. In 2010 York Capital Management came top, moving up from 10th place last year. Here is what the citation says:
"York Capital, with $11.35 billion, edged $50.9 billion Bridgewater Associates out of the lead, scoring 52.63 points out of a possible 60 and jumping nine notches from its tenth-place ranking in last year's survey. "I think the world of York's founder [Jamie Dinan] in terms of his ability and his integrity, and needless to say, I am impressed with his performance," says Richard Galanti, chief financial officer of Costco, who has been an investor in York since its inception. Adds another institutional investor in the firm: "They were very bearish at the end of '08, but then they were very adaptable when they realized that things had changed in '09... when they realized equities weren't going to be as bad as they thought, they were able to make that adjustment and to make something off of it, which is very admirable."
Investors say their main concern now with hedge fund generally is performance, as evidenced by alpha generation jumping into second place of the six factors that investors took into consideration when scoring the top 50 firms in the AR Billion Dollar Club for the report card. York, which did not restrict redemptions during 2008—which investors appear to remember—also ranked high in transparency and liquidity, two of the other six factors. Investors rated firms on alignment of interests, alpha generation, independent oversight, infrastructure, transparency and liquidity terms, scoring firms in each of those categories on a scale from 1 to 10, for the possible total of 60.
MAY LOSSES
York Capital Management’s investments in General Motors, Alcon and Xerox contributed to the York Select Fund’s negative May performance, according to a recent investor letter. The $1.2 billion fund’s private equity position in Chrysler, meanwhile, produced positive returns. York Select, a concentrated event-driven strategy, dropped 5.70% in May, but remains up 1.23% for the year.
"In May, the equity and credit markets dramatically shifted their focus from corporate earnings growth to the unfolding European fiscal crisis and the potential impact on the global recovery,” read the letter. “These macro economic concerns triggered significant market selling and investor de-risking activities overshadowing positive company-specific developments.”
York manages $13.8 billion firmwide. Chief investment officer Daniel Schwartz and partner Michael Weinberger co-manage York Select in New York.
York Select is a more concentrated version of the firm’s flagship $4.3 billion multistrategy and diversified event-driven fund, York Capital Management, which fell 4.9% in May leaving it up 3 basis points for the year. In 2009, York Select gained 82.59%, following a loss of 44.91% in 2008. Most of the Select fund’s investors are wealthy individuals and family offices. The fund is not open to institutions given its concentrated positions and high volatility.
In May, the majority of the York Select fund was heavily invested in financials (37.5% of the portfolio), materials (28%), and healthcare (14.6%).
York Select’s position in General Motors contributed to a month in the red. “Our bonds in General Motors produced losses on concerns about the sustainability of the economic recovery following the events in Europe,” the letter read.
Another losing position was the fund’s investment in eye-care company Alcon. In January, Nestlé agreed to sell its remaining interest of 156,076,263 shares of Alcon to healthcare company Novartis. But the remaining shares of Alcon have declined recently due to Novartis’ shares trading poorly and the Swiss Franc’s fall against the U.S. dollar, the letter said. York believes that Novartis will need to increase its offer in order to encourage the minority Alcon shareholders to tender their shares, given that Novartis’ offer to Nestlé is higher than the stock consideration offered to Alcon shareholders.
York’s stake in European polyethylene-maker Lyondell Chemical Company also dipped due to the general market weakness in European equities. Prior gains in Xerox likewise evaporated in the May maelstrom.
Positive positions came from the Select fund’s private equity investment in Chrysler. “After the U.S. government stake was bought out, [it] resulted in increased investor interest."
York remains concerned about the European sovereign debt situation and its effect on the global economy. “We are focused on identifying the compelling opportunities that market dislocations often offer our strategies."
All of York's funds were negative in May; The $3.4 billion York Credit Opportunities Fund dropped 4.80%; the $260 million York Global Value Partners fund fell 6.20%; the $2.3 billion York European Opportunities Fund fell 2%; the $420 million York European Focus Fund was down 3.50%; the $210 million York Asian Opportunities Fund dropped 5.70% and the York Total Return fund, the firm’s fund of funds that invests across all of its funds, was down 4.60%.
Most of York’s funds remain positive for the year. The Credit fund was up 4.48%, Global Value was up 65 basis points, European was up 5.18%, European Focus was up 3.67%, and Total Return was up 2.39%. The only fund in the red for the year is the Asian fund, with a loss of 1.07%.
