China’s Sovereign Wealth Fund in the Red

Many think that government (central banking) surpluses should be ‘invested’ through loans or through financial markets as sovereign wealth funds. They solely look at the benefits of the supposed ‘investments’ while ignoring both the hidden and the visible costs.

The recent losses of China’s sovereign wealth fund should be an example.

From CNN,

China's sovereign wealth fund suffered its worst year ever in 2011, losing 4.3 per cent on its global investment portfolio.

In an annual report that has become the focal point of its efforts to portray itself as a transparent institution, China Investment Corp also confirmed that it had received a $30bn capital injection from the government at the end of last year, boosting its investment firepower.

CIC was established in 2007 with money carved out from China's foreign exchange reserves and given a mandate to make investments that would generate higher returns. However, it quickly ran into concerns about its government background and so has been at pains to demonstrate that it is a long-term investor focused on profits, not politics.

In its annual report CIC emphasised that point, noting that its board decided in 2011 to make rolling 10-year annualised returns a key measure of performance.

"As a long-term investor, we are well positioned to withstand short-term volatility in markets, to pursue contrarian investments and to build long-term positions that can capture the premium for less liquidity," it said.

There is no guarantee that government ‘investments’ will produce positive returns.

After all, government and central bank bureaucrats are human and suffer from the same knowledge problem, as well as, other human frailties (heuristics, biases, etc..) as with the rest.

The difference is that government actions has externality effects which unduly exposes taxpayers. Yes, central banks as government institutions are underwritten by taxpayers.

The other difference is that actions by government agents or bureaucrats are driven by legal technicalities and political priorities than from the profit and loss incentives.

Besides given the huge distortions of the marketplace financial assets are subject to immense volatility and boom bust cycles, which makes sovereign wealth funds highly susceptible to market risks.