The Hindu Business Line : China's smart strategy of investing in US private equity

In what is seen as a master-stroke, China's new investment agency, set up to manage its forex reserves, is investing $3 billion into the US' largest private equity firm as a limited partner. S. VENKITARAMANAN explains how this addresses China's concerns about investing its reserves proactively and also reduces the US' fears that China may entirely move out of the dollar.

"Private equity" is the financial world's latest eye-popping creation. US private equity firms are searching for opportunities to invest across the world in the equity of potentially profitable listed firms. They typically get the companies to go private and off public listing. They restructure managements and attempt to make more profitable the enterprises they take over.

Private equity companies use leverage to expand their funds with debt. They make gains when they exit the equity of companies they turn around. This is apart from private equity firms investing in the equity of publicly-held firms, which they do to make a gain on the market bourses. Overall, private equity firms are expected to yield a higher return than the market indices. It is, in fact, the epitome of "finance capital" in the original Marxist categories.

What has happened in the private equity domain in the last few weeks is that China's new investment agency, set up to manage its forex reserves, is investing as a limited partner in the US' largest private equity firm to the extent of $3 billion. It is considered a master-stroke by China, inasmuch as it addresses its own concerns about investing its reserves proactively and, at the same time, reduces the US' fears that China may entirely move out of US dollars.

Coup Of Sorts

For Blackstone itself, it is a coup of sorts because China has excluded itself from other such deals with similar private equity firms and also locks itself from selling its stake for one year. This also gives Blackstone a cloak of respectability when dealing with China's various agencies, seeking equity investment. The very fact that China's own government reserves are partly invested in Blackstone sets it apart.

China has preferred the stake in a private equity firm to an equivalent investment in US Treasuries. It obviously values returns above risk. China has stolen a march over other countries in the region, including Japan and India. It is an object lesson in how to win friends and endear oneself to erstwhile enemies. Who can resist the lure of a $3-billion offer on the table, especially as an equity stake in the US' premier private equity firm?

Hopefully, China's gesture will speed up and render smooth the on-going negotiations between China and the US. It should, at a minimum, set at rest the apprehensions of US politicos about the dangers that China's trillion dollar-plus reserves pose to the US economy.

It should also pacify some of the Senators who have threatened China with sanctions in case its exchange rate does not "appreciate".

Masterly Strategy

The Chinese move is clever and at the same time purposeful. No longer can US Congressmen attack China continually about taking jobs off US workers. After all, it has shown its faith in the US economy by investing in a major US private equity concern.

Readers may recall how, over two years ago, one of China's state-owned oil companies attempted to buy a stake in a Californian oil firm, Unocal. The US politicos virtually killed off the attempt. The same politicos have now to swallow a repeat of the effort if it is made through the private equity firm. Definitely strategic play by a masterly Chinese regime! It is as if China is cocking a snook at the US' scanty concerns.

There is a way around even the US' masterly regulatory set-up, if one is clever enough — and generous enough — to invest in key US investment vehicles. It is true, however, that China will become owner of firms in which Blackstone invests only at second remove and have only a remote control as a stakeholder.

But the purpose of China's policy-makers to invest funds proactively in real assets is achieved. Of course, here we may be cheering too soon. US politicos may still block the move, but under what laws will they do it? It is clear that the current laws of the US will not be able to muzzle investments by anybody in a private equity firm.

China has chosen a different path from Singapore, whose role model it had set out to copy. Singapore invests its surplus in equities of various companies abroad. It also places its resources at the disposal of fund managers. But, here, an owner of forex resources has thought it fit to buy into the equity of an investment vehicle itself. This is a bold, but deliberate move. China obviously believes that Blackstone will make its investments credibly and profitably. In due course, it may profit from Blackstone with considerable capital gain.

Share in Profit

Observers commenting on China's bet on Blackstone have remarked that it is curious that instead of fund managers charging a fee for funds they manage, the private equity firm will share its fee and profit income with China's investment entity. This is as it should be. That China has staked $3 billion on Blackstone's equity entitles it to a share in the form of fee income and profit.

The Chinese have obviously factored in these as likely returns when taking a decision to invest in Blackstone's equity. The question has been raised whether the Chinese foray will induce others to follow suit. The Wall Street Journal of May 22 commented that some OPEC countries have already done a form of this deal. For instance, the Abu Dhabi's investment authority bought nearly half of Apollo Managements' listed investment vehicle last year. Similarly, Qatar's investment authority is becoming a major investor itself.

Marx, Lenin and Mao would be turning in their graves if they were to realise the full implications of China's financially astute, but ideologically neutral move. For the first time, a declared Communist regime is becoming an investor in one of the important vehicles of stock market capitalism.

Not for China the hesitations of its Indian comrades, who oppose the investment of part of employees' pension funds in shares or in mutual funds. The Chinese are more bothered about returns than about ideological purity. Obviously, they will undertake due diligence to ensure that the investment vehicles are well-managed and are less risk-prone. But they do not shy away from investments in stock markets.

Incidentally, it is nearly a year since the Singapore model was suggested for emulation by the Reserve Bank of India. China has gone miles ahead of Singapore in implementing the island-state's model. We, however, are still moving at snail's pace on this!

It is time the RBI and the Government rethink their approach to management of forex reserves. Whether there is a strong case for placing at least a fraction of the reserves in a vehicle that can undertake proactive investment in markets abroad is not clear. China has shown how to better the Singapore swing. Let us hope Mumbai will not be far behind Beijing.

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