As if it wasn't hard enough to invest $200 billion, the managers of China's new state asset agency face a new headache: growing financial protectionism.

From Germany to Canada and Japan, governments are considering curbing takeovers by sovereign wealth funds like China's of firms deemed strategically important or vital to national security.

The challenge could be particularly tough for China.

Already convicted in the court of Western public opinion for destroying manufacturing jobs by keeping its currency low, China's image has been further tarnished lately by a string of recalled Made in China goods including tires, toothpaste and toy trains.

And now it is setting up a $200 billion fund mandated to seek out higher returns from financial assets around the globe.

Investment protectionism is clearly a major concern, said Arthur Kroeber with Dragonomics, a Beijing consultancy.

With China's foreign exchange reserves growing by about $1 billion a day, the embryonic fund could have trillions of dollars to manage within a decade on behalf of a government that its foes can portray as 'evil and communist', Kroeber said.

It's going to be tricky. It's going to be not easy for them to convince people that their intentions are benign, he said.

So how will the fund, which state media say will be called China Investment Co., go about investing $200 billion?

The agency is likely to be up and running by September.

Adrian Foster, director of capital markets with Dresdner Kleinwort in Beijing, said he expected China to invest below the radar screen so it does not attract the sort of political scrutiny that scuppered state oil firm CNOOC's $18.5 billion bid for California rival Unocal in 2005.

They're aware of the backlash, and it's one reason to think their investment horizon will expand very slowly, Foster said. They'll be very slow and steady in diversifying.

BLACKSTONE LESSONS

Foster said equities would be an obvious investment choice for the new fund.

Buying small stakes in publicly listed companies that need not be disclosed would enable Beijing to avoid the publicity that came with its $3 billion acquisition of a 10 percent stake in Blackstone Group, the U.S. private equity group.

That sort of high-profile investment is likely to be the exception rather than the rule going forward because it does draw attention to those sovereign wealth funds and what they're doing, Foster argued.

Kroeber takes a different view. Buying into Blackstone would partly insulate China from political risk. If you buy direct controlling stakes in companies, people get mad, he said.

Kroeber suspected that China, as part of the deal, would send some rising stars to Blackstone to learn investing skills.

In doing so, he said, China would be emulating Singapore's Government Investment Corp.. In its early days, GIC took minority stakes in a string of financial firms to which it assigned young staffers to learn about markets and investment.

Hong Liang, chief China economist for Goldman Sachs in Hong Kong, said the fund clearly intended to groom in-house managers.

China already requires firms to offer training when it farms out part of its $1.2 trillion in reserves -- now invested largely in bonds -- to outside asset managers, she noted.

Every time they give an outsourcing mandate they always require training. They always want to learn. That's understandable, Liang said.

That being the case, Kroeber said he expected more Blackstone-type deals.

There's going to be significant Chinese investment.

Are people going to absorb that? If they're minority stakes in financial institutions, they might be able to get away with it in a way that, if it's buying up controlling stakes in resource or strategic industries, would be more tricky, he added.

George Magnus, senior economic adviser at UBS, said that as globalization increasingly takes on an Asian flavor, it would generate changes, some of which will be unwelcome in the West.

We may be only flirting with protectionism at the moment, but the roots of a more virulent strain that might well take root in the next global recession are already on full view, he wrote to the Financial Times.

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