The Austrian market is both crowded and highly regulated – not encouraging signs for current or potential participants. Things are changing for the better, but is the market ready?
One of the most important developments in the Austrian institutional market has been the implementation of UCITS 3 for investment funds. This allows a greater variety of asset classes and products for the institutional investor and higher limits for alternative asset classes like hedge funds and private equity.
Robert Löw, director at Constantia Privatbank in Vienna welcomes the new legislation. “UCITS 3 allows more absolute return than before,” he says. “We have seen more interest in absolute return products like hedge funds and real estate. This is because pension funds have long term horizons but they must show each year what they have returned. Furthermore the customer is sensitive and wants to see good returns every year after the recent bad returns for equities.”
One major issue for the pension funds, asset managers, fund administrators and custodian banks is risk management. This has been complicated by the prudent person rule introduced by the EU pension directive. In respect of this Günther Schiendl, head of investments at Vienna-based multi-employer pension fund APK notes that “the Austrian regulator has made clear that this rule will apply only to pension plans that have an approved risk management system”.
But he adds: “details are still to be specified. In essence, we face regulatory and technical issues.”
Some, such as Klaus Glaser, CIO at Raiffeisen Capital Management, believe that Austria’s Financial Market Authority (FMA) will not produce guidelines on risk management for pension funds until next year. However, he believes the guidelines for investment funds will be ready this summer.
Risk management is indeed the principle technical challenge. Schiendl: “As many pension funds have outsourced their investments in spezialfonds they have de-facto also outsourced part of their risk management. For an investment manager to invest into some of the advanced fixed income or credit products, he must be able to perform the required risk calculations, eg value-at-risk. However, because of the complexity of the products involved, this can fast become a highly complicated task and it might require a risk management system similar to that of a bank.”
Albert Reiter, managing director
of consultants explains that the extent to which this issue challenges the industry will depend on who – the KAG, the depotbank, the global custodian or the asset manager – assumes the role of risk management. “They all have a role to play to manage the requirements set out in the directive,” he says. “They have to work together perfectly but over the next few years; we should consider that the open architecture that develops may not work so well.”
The decision of the regulator as to whom the FMA will make responsible for risk management is eagerly anticipated. “We think that the KAG will be made responsible for this,” says Friedrich Strasser, member of the board at Vienna-based boutique bank Gutmann KAG. “This is probably the best way. But this will make it more difficult for each manager because it will have to decide what risk freedoms to allow the client.”
As a result of the complexity of the risk management function a bias towards certain types of investment may develop. “If an Austrian institution buys into an Austrian equity Spezialfonds the Austrian KAG will not need a global custodian because everything can be bought on the Vienna stock exchange,” says Reiter. “There will be no complex IT issues because the risk management report comes from one system. But if the mandate is a global balanced mandate an Austrian KAG would need a global custodian which would give rise to the question: who produces the risk management report?”
There are similar challenges for the institutions which may be cause for concern in the longer term. “How do they consolidate all their investments?” asks Reiter. “Institutions may switch to a more simple spezialfonds or even certificate structures to avoid the consolidation problem.”
We should be wary of the possible consequences of the new risk management requirements. “For us it means that if we want to give a mandate in the form of a segregated account to an absolute return manager who is using various complicated forms of credit, fixed income and other derivatives, the restrictions on the manager’s strategies are set by the custodian bank’s risk calculations capabilities,” notes Schiendl.
Glaser agrees that the coordination with the custodian banks could be problematic but notes that “competition will take care of this”.
The structure of competition in the Austrian market may also be influenced by the fact that non-Austrian custodian banks will be allowed to hold Austrian pension funds assets for the first time when the pensions directive is implemented in September.
But perhaps foreign managers need not expect too much. “The pricing in Austria for custodian services is very low on an international level due to the high density of banks in Austria,” says Löw. “Price and communication and service are important so domestic banks will have the advantage. It is a small market, everyone knows the other.”
The new investment law – the local implementation of the EU pensions directive – leaves much to be desired, according to some. “If the prudent person rule has to be used we also need asset liability management,” says Thomas Biedermann, member of the board at multi-employer pension fund Victoria Volksbanken in Vienna.
His criticism relates to the so-called VRG. Multi-employer pension funds such as Victoria Volksbanken or APK each have several VRGs, literally investment and risk communities, which are structures that are designed to spread the investment risk among as many people as possible. Typically several employers will be catered for by a single VRG. Each must have at least 1,000 members.
“They adapted the law to the needs of the EU directive but didn’t think of the problems regarding how the pension funds would carry out asset liability management,” Biedermann continues. “The authorities forbid pension funds from making different asset allocations within the same VRG so funds cannot adapt the asset allocations to the different age profiles of the different employers within a given VRG. The authorities simply refuse to deal with it which is a very unsatisfactory situation.”
He explains that pension funds could offer more than one VRG per client. “But this doesn’t solve the problem for existing clients. The Financial Market Authority – while it can’t prohibit it says it is not in the sense of the law.”
He concludes: “The Austrian pension fund law needs to be rewritten as a whole in my opinion. The law should be re-written to allow pension funds to do what they are supposed to do.”
The regulator also seeks to bind the hands of investors in terms of the range of permitted investments. “Asset managers and fund administrators currently can use short credit as well as currencies only for hedging purposes,” notes Schiendl. “This however limits their ability to pursue credit and currency strategies to the extent that managers supervised by different regulators can do.”
But Löw is not so concerned: “There are limits on currency and credit strategies but they are not so dramatic. Some 80% of what the asset manager wants to do in the fixed income area he can still do. Some credit swaps are no longer possible.”
The EU pension directive will make it possible for insurance companies to offer second pillar pension products. “Second pillar products are very important for insurance companies,” says Löw. “It is lucrative without the risk. The pricing is important, as is the guarantee and here insurance companies have the advantage over pension funds. The guarantee is so important due to previous losses on equities. In two to three years they may have 20% of the business.”
As elsewhere in Europe we are seeing increasing interest in smaller, independent niche managers. “We prefer boutique managers with a single or very few products,” says Schiendl. “We feel their narrow focus, manager-ownerhsip and the fact that they have more to loose if their product does not perform results in a more enthusiastic and engaged approach.”
Reiter agrees: “I fully support this view,” he says. “We are seeing a division of the alpha and beta worlds through the development of the core satellite approach. The whole market will divide into 10% high alpha with well-proven managers, many boutiques among them, investing in small/mid-cap, emerging market and high-yield. There will be a battle for the rest between the most efficient managers with cost pressures on index-oriented products.”
The performance of the local market and those of Austria’s central and east European neighbours has given local managers an edge. The Austrian stock market returned 40% last year and 11% in the year to date. “With the strong performance of Austrian equities - in part a European mid-cap story, in part the CEE story, in part due to takeovers and also due to strong results of the companies – the Austrian equities funds have drawn in more recognition recently,” says Schiendl. Strasser agrees: “Against foreigners Austrian banks are doing well. They are the market leaders in eastern Europe, and Austrian bond funds are among the best in Europe.”
As the market grapples with regulation and risk the niche that Austrian managers are carving out for themselves in central and Eastern Europe will be significant in securing their competitiveness in the international marketplace.