UPDATE 2-China wealth fund suffers first-ever profit fall

Wed Jul 25, 2012 8:19am EDT

* CIC posts first net profit drop since 2008

* Says choppy markets hurt stock investments, sees more turbulence

* Doubled private equity, alternative investments in 2011

* Sharply increased investment in govt, govt agency bonds

By Koh Gui Qing and Langi Chiang

BEIJING, July 25 (Reuters) - China's sovereign wealth fund China Investment Corp. suffered its first-ever drop in net profit in 2011 and predicted tough trading conditions may persist as volatile financial markets dent stock investments.

But in a sign the $482-billion fund is sticking to plans to become a more aggressive investor, CIC doubled its investment in private equity, direct investments and hedge funds in 2011 to 43 percent of its portfolio, compared with 2010.

It said its private equity and direct investments were focused on sectors such as energy, resources, real estate and infrastructure.

"Looking ahead, the global economy will continue to recover but the process will be fragile," CIC Chairman and Chief Executive Lou Jiwei said in the fund's 2011 annual report released on Wednesday.

"With fresh volatility in the financial markets still posing serious risks, CIC will adhere to prudent investment approaches."

CIC said it earned a net profit of $48.4 billion in 2011, down 6.1 percent from a year ago. The drop in earnings was matched by its worse-ever return on overseas investment since it started publishing annual reports in 2008, at minus 4.3 percent.

Private equity and direct investments accounted for 31 percent of total investments last year, CIC said, while hedge funds accounted for 12 percent.

That is a marked rise from 2010 when CIC invested only 21 percent of its portfolio in private equity and hedge funds, and just 6 percent in 2009.

"The key point is that CIC is divesting into private equity, so more volatility is to be expected," said Michael McCormack, an executive director at Z-Ben Advisors in London.

He said despite the drop in net profits, CIC still outperformed the MSCI world equity index, which he believes is the best proxy for the fund's overseas investments. The index shed 9.4 percent last year.

"So even with all the new private equity investments, we're seeing CIC outperform the wider market," he said.

MORE GOVT BONDS, FEWER STOCKS

CIC's growing interest in private equity is in line with its strategy to transform from a slow-paced, low-return sovereign investor into an institution that chases higher returns and plays a bigger role in dealmaking.

To accommodate its focus on private equity, CIC said it has extended its investment horizon to 10 years, and would use a rolling 10-year annualised return as its main performance measure. It said it had invested all its capital in 2011.

A breakdown of its fund distribution showed it pared its stock holdings to make room for other assets. Stocks took up 25 percent of CIC's portfolio in 2011, down from 48 percent for equities in 2010.

CIC said it suffered losses in its stock holdings last year as rising oil prices, Japan's tsunami disaster, policy tightening in emerging markets, Europe's debt crisis, and the U.S. credit rating downgrade roiled markets.

It highlighted energy and resource stocks as being badly hit. Recent private equity investments that have yet to earn returns also dragged on overall performance, the fund said.

But CIC said turbulent markets benefited its bond and credit investments, which outperformed stocks.

Its holdings of government and government agency bonds ballooned to 69 percent of its total fixed income portfolio, up sharply from 47 percent in 2010. Its total fixed income holdings rose around 11 percent to $39 billion in 2011.

The annual report did not give a breakdown of how CIC is invested across regions, though it did show the fund is most invested in North American equities, at nearly 44 percent. Asia Pacific equities was at a distant second at 30 percent.

CIC was reported in June to have cut its stock and bond investments in crisis-stricken Europe, but it made no mention of pulling funds out of the region in its annual report.

Created in 2007, CIC was tasked to earn higher returns from riskier investments using part of China's foreign exchange reserves, which at over $3 trillion are the world's largest.

On a cumulative annualised basis since CIC's founding in September 2007, the fund's 2011 return was 3.8 percent, down from 6.4 percent in 2010.

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