China sovereign wealth fund diversifies into a massive loss

We have seen absoultely catastrophic losses at the world’s Sovereign Wealth funds in the Middle East, Singapore, Norway, you name it.  Add China to this list.  China’s State Administration of Foreign Exchange diversified its money out of Treasuries and agency debt at absolutely the worst time, running into a buzz saw as equity markets tanked.  Now they are sitting on huge losses. 

My highlighting is below.

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 $2,000bn (€1,547bn, £1,429bn) 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 $1,800bn 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 $160bn worth of overseas equities, Chinese losses on those investments would exceed $80bn, 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 $100bn 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 $4bn. 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.”

When one looks at Premier Wen’s recent comments about the safety of U.S. assets in the context of massive losses in our equity markets, it starts to make a little more sense. Effectively, the Chinese have gone from one poor investment to another as they have looked to invest their massive foreign reserves. Given the fact that China has accumulated these reserves because of an extreme imbalance of savings and investment between Asia and the West, one can see these imbalances as having ruinous consequences on all sides.

How the Chinese SWFs escape future losses is beyond me. But, obviously, they have no one to blame but themselves. No one forced them into building a huge arsenal of depreciating paper money.