German institutional and pension investors are still hesitant to diversify their equity portfolios to other regions globally, particularly Asia, led by what is considered a lack of information and misconception about the region, which may cause them to likely miss out on potentially higher returns.

According to a research study by the Frankfurt School of Finance and Management, there are two reasons for the German institutional investors’ home bias: the risk of investing abroad, and particularly in Asia, is “strongly perceived ”, and that investors consider information on the home market – Germany and Europe – as a means to achieve better returns, Olaf Stotz, professor of asset management and pension economics at the Frankfurt School of Finance, told IPE.

“But these are perceptions distorting the reality. In reality, the Asian market is less risky than it is perceived,” he added.

According to the study, which was authored by Stotz and commissioned by Nomura Asset Management Europe, institutional investors in Germany miss out on returns worth €15bn per year because the German and European equity markets have performed poorly compared with the world equity index – a difference of 1.15% per year – and the future performance of the German and European equity index remains uncertain.

According to Refinitiv Datastream, a comprehensive financial historical database, the market capitalization of equity portfolios globally was around €78.8trn in mid-2021, and the German stock market was worth around €2.21trn.

The German stock market has a share of 2.8% of the world equity portfolio. European equities weight 10% of the capitalisation of all stocks but are over-represented with more than 40% in the portfolios of institutional investors – the 35% difference quantifies the home bias, the study showed.

“One thing that is certain is that there is a higher risk by investing in the home equity market,  […] €8-9bn results in the risk of investing at home and this will remain stable in the next years” Stotz added.

The study analysed Deutsche Bundesbank data, aggregating information of German institutional investors. Pension funds, which represent a large share of institutional investors in Germany, have communicated the data to Deutsche Bundesbank, and have, therefore, a similar home bias to other institutional investors and overweight German and European equities, Stotz explained.

Deutsche Bundesbank measures the market value of equities in Publikums and Spezialsfonds of German institutional investors that had a domestic equity allocation 19.3% in mid-2021.

The difference between the allocation to German equity and the allocation to global equity gives a further idea of the home bias, 16.5% as of mid-year 2021, the study said.

German institutional investors allocate around €624bn to equities, €268bn (43%) invested in the euro zone, €177bn (28%) in the US, €35bn in the UK, and only €24bn (4%) to Japan, €4.9bn to China (0.77%) and €4.5bn to India (0.70%).

Among German pension funds SOKA-BAU, the umbrella organisation of the two pension funds for the employees in the construction industry ULAK and ZVK with assets under management of €12.8bn, aims to hold about 30-35%, or one third, of each asset class in Asian markets. Its portfolio is split into more than 50% bonds, 16% equities, 27% real estate and close to 5% in private markets.

Olaf Stotz at Frankfurt School of Finance

Olaf Stotz, Frankfurt School of Finance

Bayerische Versorgungskammer (BVK), with €100bn in assets under management, has grown its private equity investments in the Asian market, and 9.9% of its real estate portfolio invests in Asia, compared with 44.3% in Germany, 24.7% in the rest of Europe, 18.5% in North America, 1.3% in Australia and 1.2% in South America.

BVV, the pensions provider for the German financial sector, has reinforced its equity programme for infrastructure and real estate in Asia to benefit from growth opportunities in the long-term.

Pension funds, and all institutional investors, can avoid risks relating to home bias, allocate abroad and achieve higher returns for their members, Stotz added.

Over a 10-year period German equities have performed worse (7.42%) than Japanese equities (8.24%) and in line with Asian equities (7.65%), calculated on the MSCI country indices.

Investors may also face a bumpy year ahead as in 2021 the MSCI AC Asia Pacific ex Japan Index, which captures large and mid-cap across eight emerging markets covering approximately 85% of free float-adjusted market capitalisation in each country, was down 2.65%. Chinese blue chips (CSI300) lost 6% and Japan’s Nikkei gained a modest 4.6%, according to Reuters.

The bigger picture

According to Gerhard Engler, managing director at Nomura Asset Management Europe, German investors feel they are missing the full picture in terms of culture, and first-hand information on Asia, while China dominates the perception as a rivalling system to democracies.

“China is perceived sometimes as being over-protective of its domestic economy and dangerous to foreign investors. However, if you look at the economic growth, consumption, export, and population you will find from a financial standpoint that it makes sense to invest there,” he told IPE, adding that the markets in Indonesia and India also performed very well last year.

“With high conviction portfolios, returns can turn out even higher and thus add value to equity portfolios, particularly for pension funds,” he said.

The main part of Nomura’s managed assets in its Frankfurt-based European entity are in fact pension assets, with equity investments in Asia and similar strategies available as UCITS vehicles and segregated mandates/Spezialfonds.

The strategies are both for investors focused on asset liability matching indices, and investors looking to boost returns and manage risks through high-conviction approaches and core investments in the Japanese market.

“Investors who can tolerate volatility and have flexibility often opt for the high-conviction solutions because they see the potential for outperformance over a [economic] cycle,” Engler said.

“Investors who can tolerate volatility and have flexibility often opt for the high-conviction solutions because they see the potential for outperformance”

Gerhard Engler, managing director at Nomura Asset Management Europe

“Last year, high conviction mandates grew in popularity and showed good returns, and even this year we have not seen significant redemptions despite the overall “risk-off” mood,” Engler said, adding that Nomura is also observing clients buying into its inflation-linked bonds strategy for concerns over inflation.

Changing perceptions

Institutional investors should change past habits, question certain behaviours and critically analyse whether the perception of having better information to invest in German and European markets ultimately translates into better investment results, Stotz said.

Investors should consider not only the impact of political decisions on the economy but also if the investment chain is impacted by policies. In the long-term what matters, Stotz argued, is that the human capital of companies from China and India, which only make up a small share of the market capitalisation on the global equity market, is currently under represented.

“The young generation from those countries studies abroad and the human capital will probably be more profitable in the future, independently from political risks in [those countries], and this aspect would ultimately be mirrored in equity markets and in the portfolios of pension asset owners,” he said.

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