Case for bespoke asset management
Spezialfonds remain a preferred method of investment for institutional investors. But Till Entzian finds that the investment vehicle could be under threat from AIFM guidelines
In 2008, investments in securities Spezialfonds represented by the German Asset Management Association (BVI) fell to their lowest in five years. With inflows of €17.8bn, this amounts to an increase of 2.7% compared with 2007’s figure of €670.4bn, resulting in the lowest inflows since 2004, at €17bn. This can be explained by the increased need for liquidity among institutional investors as a result of the financial downturn, leading to outflows from Spezialfonds. Additionally, a collapse in profits will often lead to a lack of cash reserves, meaning fewer reinvestments are possible. Examining the results from this perspective, one can nevertheless consider the low net inflow a success for the investment industry, as it demonstrates the durability of Spezialfonds in the minds of many investors.
Despite the comparatively heartening inflow, the volume of securities Spezialfonds managed actually fell by 7.7%, from €670.4bn to €618.5bn. This moderate loss pales in comparison with the stock markets, which experienced a drop of around 40% over the same period. Spezialfonds also proved more robust when compared with securities-mutual funds, which fell 24% to €491.6bn. Next to the inflows and a relatively low equity allocation, this can also be attributed to the skilled implementation of capital insurance strategies within Spezialfonds, as requested by many low-risk investors.
Including open property funds, BVI members combined managed €640.4bn in Spezialfonds, amounting to a larger volume overall than amassed by mutual funds, which only totalled €575.8bn. The volume of Spezialfonds in the 1990s originally exceeded that of mutual funds. However, in both 2006 and 2007, mutual overtook Spezialfonds. This can also be attributed to the current market climate, as well as a stronger preference for equities among mutual fund investors.
Any further developments will be harder to predict. However, for the current financial year the hope remains that there will, at the very least, be no further market slumps, and that inflows will continue along this currently low, but stable, level. In the first four months of this year there was a market-related increase in the value of Spezialfonds of approximately €6bn. At the same time, each balance sheet saw an equal increase of funds, resulting in a 1.9% increase to €630.4bn in the volume of securities Spezialfonds.
The slow development of inflows over the last year is mirrored in the situation faced by Spezialfonds. While no groups closed in 2008, there were also no new entries to the market. In fact, there were only two internal mergers between providers. In the first merger, Hamburg-based Nordinvest Norddeutsche Investment-Gesellschaft joined Pioneer Investments Kapitalanlagegesellschaft, now based in Munich. With Activest, it was itself already a spin-off from ADIG. The newly created company began operating from 2 July 2008.
The second case involved SEB-Gruppe which, during the course of 2008, had already consolidated its property and securities operations into SEB Investment. This resulted in five rival investment groups dealing with both property and securities companies, namely AmpegaGerling Investment GmbH, AXA Investment Management, Hansainvest Hanseatische Investment and MEAG Munich ERGO Kapitalanlagegesellschaft in addition to the SEB-Gruppe already mentioned.
In addition, there were two takeovers. The listed Dutch KAS Bank bought Delta Lloyd Investment Managers on 1 July last year. It now trades as KAS Investment Servicing. From the name it is evident the emphasis for the newly created company now lies in the administration of master funds and no longer with asset management. The other noted takeover was of Veritas SG Investment Trust, which was bought by Argur-Gruppe on 1 August last year. The new name removes any mention of previous owner SocGen, with the organisation renamed as Veritas Investmenttrust. The new owner is in fact a Luxemburg-based SICAV private equity fund, which hopes to capitalise on what it perceives to be a growth market in the area of funds of funds, in particular ETF funds of funds.
There is one further takeover worth mentioning, although it was not finalised until early in 2009. Commerzbank’s acquisition of Dresdner Bank from Allianz went through on the basis that Allianz Global Investors Deutschland would gain ownership of Cominvest Asset Management. Cominvest itself merged with ADIG in 2002, giving it claim to an established heritage, as ADIG was the first German investment group, founded in 1949 by four banks in Munich. The acquisition of Cominvest, therefore, allows Allianz Global Investors to demonstrate that it is not only the largest German investment group, but also the one with the longest history.
In early 2009, Union Investment also bought out 40% of Boston-based PanAgora Asset Management Inc, having owned 40% of PanAgora Asset Management since their joint venture began back in 1999. The remaining 20% stake was in the hands of key investors, as well as key company personnel. However, when it was renamed Quoniam Asset Management, the company did not lose one of its unique aspects, as unlike many firms in the investment field, management still holds a stake. In fact, the share owned by management has now increased to 25%, with the main focus remaining squarely with quantative investment strategies.
Finally, there were several additional name changes. Deutsche Bank Group’s institutional asset management business, previously trading under the moniker DeAM is now known as DB Advisors. The name change is designed to accentuate its involvement in the traditional areas of institutional asset management with its investments.Previously, Deutsche Bank had several of its alternative investment products under its RREEF banner and renamed all of its property companies accordingly. Other notable changes include the German branch of the Fidelity Group trading as FIL Investment Management since July 2008 and more recently Société Générale Securities Services Kapitalanlagegesellschaft (KAG), which shortened its name to simply SGSS Deutschland KAG.
Breaking the value chain leads to differential specialisation
The tendency for master KAG solutions is set to continue, with the number of securities Spezialfonds last year falling below 4,000 for the first time since 1997. While the reduction from 4,107 at the end of 2007 to 3,885 at the end of last year may not seem too large a decline, there has been an almost 30% reduction in Spezialfonds since the market peaked at 5,600 in August 2001. This is only partially connected with outflows and can in fact, be traced almost entirely to the mergers in Spezialfonds.
In some instances, small and unprofitable Spezialfonds have merged, allowing for an unknown increase in multiple investor funds. More important, however, is the merger of Spezialfonds belonging to the same investor or company. This is a marked turnaround from the previous practice from the 1990s up to the stock market crash of 2001, which usually involved each new and different asset assigned to a unique Spezialfonds.
In fact, it was sometimes the investor’s goal to spread the assets accumulated in Spezialonds over different KAGs, thus allowing for a comparison of performance and service. All this changed once the first so-called master KAG came into existence. This enabled the management of portfolios to be outsourced, allowing for the administration of segmented Spezialfonds. Through this structure, investors can benefit from a unified reporting system across all fund segments, and decrease the risk of having to write off any losses in specific assets against the value of the Spezialfonds. However, the system does come with certain drawbacks, such as the duplicated effort of having to conduct bookkeeping and risk management on both the master KAG and the external manager side. In comparison, the problems that initially developed with the underestimation of crossovers seem to have been resolved for the most part, helped largely by the BVI’s development of XML as a standard.
The data now collected by the BVI, for the first time allows us to chart the above described segmentation of Spezialfonds. In the four years from March 2005 to 2009 an estimated 850 Spezialfonds ceased to exist. However, if each disappearance can be counted as a merger of two Spezialfonds and each merging Spezialfond split into two segments, there has been in fact, a growth of 1,700 segments, with the BVI statistics reporting a growth of 1,729. However, since many Spezialfonds have already been transferred to segmented mandates, this growth can be put down to a reorganisation of existing fonds.
Whether this trend of segmentation has peaked remains to be seen. At the end of last year 3,532 segments were accounted for, with only a small reduction of 20 witnessed by March 2009. Of note, however, is the fact that the majority of Spezialfonds are segmented, with €348.1bn of funds here, compared with only €270.4bn found in regular Spezialfonds. In theory, any and every company is able to start its own segmentation. In practice, however, this is often only the case with a master KAG when the administered funds visibly exceed the managed volume. Ten master-KAGs have resulted from this development. Conversely, there are 12 companies emphasising investment advisory and portfolio management. The remaining KAGs, approximately 30, can be viewed as offering both, as neither asset management nor portfolio management is the dominant business model.
The movement of companies towards either specialisation as a master KAG or a portfolio management KAG occurred mostly between 2003 and 2007. Since then, the configuration in both groups has not changed dramatically, especially as the long-predicted period of consolidation failed to occur. Surprisingly, even small companies can continue to stand on their own in this market, although the master KAGs continue to pride themselves with the fact that they will be able to continue the above-average asset growth seen in the last few years.
In the periods examined here, master KAGs were able to account for an 11.9% increase in volume of Spezialfonds, a growth twice as strong as the rest of the market. Experts often point to the significant net inflow of funds during the market slump of 2002-03, the time when the master KAGs were created. Institutional investors saw the benefits offered by standardised reporting when restructuring Spezialfonds, resulting in the liquidation of direct investments and a reinvestment in Spezialfonds. This led to a growth in cash flow which otherwise, with a simple restructuring of the already existing Spezialfonds, would have seen neutral asset flows.
The total administered worth of securities assets ran at €923bn as of 30 April 2009. (figure 1, with the cumulative value of the various groups). Almost two-thirds of the assets are found in Spezialfonds (€630bn), with the remaining third to be found outside of investment funds (€293bn).
In the breakdown of these funds among the main companies, Allianz’s Global Investors KAG lays claim to the biggest sum invested of €203.9bn, equally split between Spezialfonds and funds accumulated outside of investment funds. In second place is Generali Investments Deutschland KAG, managing over €74.8bn, followed by Universal-Investment with €71.4bn. While the emphasis with Generali’s KAG lies with funds accumulated outside of investment funds (94.3%), 95.3% of the funds Universal-Investment administers are allocated to Spezialfonds.
The outsourcing of administration does not play a deciding factor with investment funds, however. In relation to these, it is interesting to note that €256.3bn of the total €630bn in assets can be found in funds managed by one of the master KAGs. The largest amount of Spezialfonds where responsibility for administration has been outsourced lies with the €61.9bn managed by Universal-Investment. Other companies that currently manage third party Spezialfonds assets of over €20bn in comparison are the Internationale Kapitalanlagegesellschaft (INKA), administering €44.5bn, and Helaba Invest KAG, with €25.4bn.
In total, Spezialfonds and funds accumulated outside of investment funds amounted to €816.0bn until 30 April, 2009 (figure 1). This might be €100bn lower than the total sum administered, but it underlines the appeal of the infrastructure offered through administration in Germany for foreign investors.
The market crash: equities are out, bonds are in
The recent market trouble has left visible scars in the composition of assets within securities Spezialfonds. The percentage of equities under management fell to a 10-year low by 31 December 2008, dropping by 13.8%. A year ago, this number was twice as much, at 27.3%. This development can most likely be traced back to the Spezialfonds’ retreat from the stock market, as well as general market weaknesses. The drop is, however, not as drastic as at the turn of this century, when the percentage of equities fell from 46.2% at the end of 1999 to 25.7% by the end of 2002. Since then, the proportion has been fluctuating between 25% and 30%.
While the percentage of stocks might have decreased, bonds have rallied and in 2008 accounted for 66% of all assets in funds, up from 57.4% and reaching a 10-year high. These, along with bank deposits and money-market securities, witnessed an increase in demand last year, with the latter two for the first time hitting double digits at 11.5%.
The first three months of the current year did not show any signs of change, with the percentage of stocks sinking again and staying around 11.8%.
Within fixed income, one thing has become clear, namely the shift from national to international bond holdings. Since the end of 1999, the percentage of domestic bonds has fallen from 33.9% to just 21.4% by the end of 2008. During the same period, investments in foreign issues rose from 13.2% to 47%. A similar development can be seen in stock investments, with foreign shares becoming more dominant than domestic. Both developments can be explained easily by the introduction of the euro as the unified currency, strengthening the position of foreign assets.
Groups with differently weighted assets
The calculations made by the BVI at this point allow us to examine the composition of the various Spezialfonds across the KAG groups, such as bank and insurance owned entities. While there has been a halving of equities across all KAG groups during 2008, there is a notable difference in the case of income stocks. Depending on whether investments were made by companies from the Sparkassen and state bank sector, or by privately owned banks, the proportion of income stocks could be either 8.8% in the first case or 18.2% for the private banking sector. Investment companies run by co-operative banks are in between, with 11.8%, regional banks, 13.2%, insurers, 13.2% and foreign banks at 13.3%,
Fixed income demonstrates an even bigger disparity. While KAGs run by privately owned banks only reached a 48.4% allocation to fixed income, this rose to 74.6% for KAGs run by insurance companies. Entities owned by foreign banks reached 59.4%, with Sparkassen and state banks slightly exceeding this level at 60%. Fund companies run by co-operative banks reached a 61.9% share, with large and regional banks above that at 66.2%. Compared with the results at the end of 2007, it is clear that the biggest increase in fixed income was achieved by the co-operative banks and insurance companies. The percentage of bank deposits and money-market securities varies between 4.7% at the insurance company KAGs and 19.2% with those workers at the Sparkassen and state banks. Private banks’ investment companies rely more heavily on investments in target funds with a 12.3% share, while the share of total assets can vary, starting as low as 1.3% and hitting 7% according to the sector.
These differences, of course, do not reflect the preferences of the various investment companies, but represent the needs and interests of each investor.
Spezialfonds are often also called ‘Gemische Wertpapierfonds’ (mixed investment funds), which should not be confused with the Germany legally-regulated fund type of ‘Gemischten Sondervermögens’. With the former, there are none of the investment restrictions found in the latter, leaving investors open to acquire both stocks and bonds. As of 31 December 2008, 60.6% of the funds’ assets could be found in this category, with a further 23.3% invested in bond funds and another 10.4% placed in equity funds. These figures highlight the flexibility investors prefer with Spezialfonds in terms of asset bands. If the terms under which the portfolio managers are allowed to trade are worded satisfactorily, it allows them to react to any capital market development that might occur, allowing for the movement of assets in real time.
With regard to types of funds, it is useful to clear up any misunderstandings. Since KAGs have been given permission by investors to deviate from the legal guidelines, many believe that this removes the various types of funds found in Spezialfonds. In fact, any deviation from legal guidelines with the permission of investors represents a special case. Usually, investors would not give permission to deviate and in this case, which represents business as usual, Spezialfonds still have to follow the guidelines of the type of fund it represents, be that the ‘Richtlinienkonforme Sondervermögen’, the ‘Gemischtes Sondervermögen’, the ‘Sonstige Sondervermögen’ or the ‘Grundstückssondervermögen’.
Usually, the discussion on reversing the type of fund is not in question, but once the investor gives permission to deviate from the legal guidelines, a question has to be answered: is a readjustment to the original type of fond still possible, or has the Spezialfonds in question now moved beyond the limit of what defines a fund in legal terms? Now, of course, the so-called ‘white flag’ Spezialfond becomes a possibility, with the investor removing all the investment guidelines and the KAG now allowed to chose from all assets mentioned in investment law.
Unfortunately, we have no data on how widespread these completely free Speizalfonds are. With some investors, eager to pursue specific investment ideas, this type of fond has apparently been met with great interest. The so-called non-specified Spezialfonds still remains in the minority, with most deciding to remain with the type of Spezialfond they have already established.
Investment patterns are stable
Over the last 10 years, investment patterns have remained mostly stable, with only minor fluctuations. Insurance companies and pension funds combined account for more than half of all investments, taking a 51% share, up from 49.5% in 1998. In fact, the €90bn invested by pension funds constitutes 15% of all monies invested in securities Spezialfonds. Indeed, this share has grown by 3.5 percentage points since 2005 alone, although it is hard to accurately measure the growth before, as federal statistics have only recorded pension funds separately from insurance companies since 2004.
The second-largest investment group comprises various banks that lay claim to 21.1% of the securities Spezialfonds market, showing a 3.3 percentage point drop in the last 10 years.
Less present in this market are other companies, as well as industry and employer associations. Their involvement has fluctuated in the past decade and while, overall, their share has increased from 18.3% to 19.3%, it has fallen off slightly from its 2007 peak of 20.4%.
Various social security institutions and public companies that offer supplementary benefits, as well as various non-profit organisations (such as churches, political parties, unions and associations) have marginally increased their market share, at 2.9% and 5%, respectively, between 1998 and 2008.
The financial crisis has apparently caused many institutional investors to return to more traditional strategies, with more transparent products that lean towards benchmarking and risk management systems. Closer attention is now paid to counterparty and issuer risk, with particular attention to the liquidity situation. Assets associated with a higher risk are less in demand, while there has been a renewed interest in corporate bonds, with inflation-protected stocks yet to become an important topic.
Investors and supplier groups
Traditionally, insurance companies will seek to invest with investment groups that are connected to the insurance market. Over 75% of all monies administered by these investment groups can be traced to insurance companies. In comparison, other investment groups with market shares of less than 10% cannot hope to play a part. The unique structure of the co-operative and Sparkassen groups, reflects 50% and 44% respectively of all funds for their KAGs coming from banks, with another 35% and 23%, respectively, stemming from insurance companies.
Towards the end of 2008, most private organisations preferred to entrust their funds to regional banks and their capital investment groups .
Pension fund investors tend to prefer capital investment groups close to private banking institutions, closely followed by investment groups that are subsidiaries of foreign banks and insurers. KAGs of co-operatives and regional banks tend not to play any notable part for these investors.
Pension funds rank at the top with inflows in 2008
The greatest inflows of 2008 can be traced back to pension funds, with €14.8bn of new investments made by this group into various securities Spezialfonds, up dramatically from only €4.3bn of new investments in the previous year. The same group of securities Spezialfonds saw €8.7bn flow in from insurance companies, down almost half from the previous year’s €14.8bn. In stark contrast to both of these investments is the banking sector, which withdrew €6.1bn of funds - which can possibly be explained by the need for liquidity during the economic downturn. Already as early as 2007, this investment group saw outflows of €2.7bn. Additionally, other organisations (such as industry and employer foundataions) saw outflows totalling €1.2bn, after the previous years’ new investments to the sum of €8.9bn.
Luxembourg’s importance as a Spezialfonds destination is negligible
In 2007, Luxembourg enacted a new law targeting Spezialfonds (Specialised Investment Funds, or SIFs), which determined that all rules governing this particular product would be unified. Luxembourg’s legislature was not only trying to make the country as attractive as possible by making the paperwork easier to navigate, however, as more liberal rules surrounding investment and investment policies were meant to draw more Spezialfonds to the Grand Duchy.
Under the new legislation, Spezialfonds were opened to private investors, rather than just the traditional institutional investors. This was, however, on the basis that each private investor had sufficient knowledge of the field and/or had a minimum investment of €125,000. Management of the portfolio is regulated in a similar fashion to Germany, with few limits as to which investment tools can be used. As a result, Luxembourg’s Spezialfonds are designed and tailored to an individual’s needs. For example, for alternative investments for family offices. Overall, the impression is that the Luxembourg SIF is targeted at wealthier private investors, rather than the larger institutions.
Cultivation of this market began slowly towards the end of 2006, when the first German-based Spezialfonds relocated €330m of funds to Luxembourg. Just a year later, five German capital investment companies had set up 15 funds with a total volume of €847m, with inflows reaching €413m over 2007. Even the financial crisis did not deter investors, with the number of total funds tripling to 47 in 2008, administered by eight capital investment companies based in the country. The value of the funds increased seven-fold to €6.2bn by the end of last year.
Finally, in the first three months of 2009 a further fund company was set up in Luxembourg, with the total number of Germany-domiciled Spezialfonds increasing to 56, accounting for a volume of €8.1bn in total.
However, the actual market share accumulated by Luxembourg is relatively modest and experts are debating whether this is likely to change. While there are now hardly any regulatory reasons for securities-mutual funds to flow into the country as in earlier years, there are nonetheless cautious voices warning of a situation where competition could be distorted, leaving Luxembourg as a central European hub for pension pooling. This process, which would see pension assets pool in one area or country is also possible under the German system, given the correct managerial and portfolio choices in regard to master funds. However, the risk of Germany being relegated cannot be dismissed out of hand, despite the similar regulatory conditions. A blend of old habits and simple investment psychology could make Luxembourg the more attractive option for international investors, which historically tend to approve of ‘neutral’ countries as their European base. Once funds are established, this could shift the balance irrevocably in favour of the Grand Duchy.
In addition to these points, Germany does not have investment funds that can be judged as transparent by double taxation agreements, which complicates tax matters for foreign investors looking to pool their pension funds. Therefore, it is of paramount importance for German legislators to highlight the advantages of German Spezialfonds in general, but also pension pooling in particular.
The future of Spezialfonds
As previously mentioned, net inflows of 2.7% prove that the Spezialfonds are still an attractive way of investing for many institutional investors for several reasons, ranging from investors’ familiarity with the legal framework, through to the regulatory oversight offered by BaFin and the internal audits undertaken by the depotbank, KAG and auditor, and not least in terms of the legally permissible fund types.
In the past, proposed changes to tax laws have often proven to be the biggest risk to Spezialfonds, as they could have placed the funds and those who invest in them in a less favourable position when compared with other investors. This year, however, no such changes are in sight. Instead, the European Commission, with the German Government’s support, is proposing a Directive for the regulation of alternatively managed investment fonds (AIFM Directive).
The proposed AIFM Directive is supposed to help prevent any further financial downturns by closely monitoring and regulating all alternative investment routes. To a certain extent this is reminiscent of the legend of the Chinese general and his quartermaster. While out on a long campaign in the field, the quartermaster often reminded his general of the declining state of supplies, but the general did not take note until supplies had dwindled so much that rationing began and discontent spread among the troops. With mutiny on the minds of his troops, the general swiftly assured the quartermaster that his family would be well cared for and had him decapitated in front of the troops. Mutiny was averted by the general dealing swiftly and harshly with the person supposedly responsible for the soldiers’ plight.
As they currently stand, the AIFM guidelines could spell the end for several financial products that have played little part in the current financial upheaval. No one has yet, for example, blamed open property funds or Spezialfonds for the world’s current economic turmoil. The same could even be said of hedge funds, which are supposed to be central to this Directive. That said, politicians at the highest level both in Berlin and Brussels have agreed to regulate these areas in an attempt to tackle the global financial crisis. Under the current proposals, Spezialfonds would also have to prepare for the following changes:
• a sign-off on the existence of the Spezialfonds, as well as any changes made to its terms and conditions (previously abandoned by the BaFin in 1990 as a means of relieving its workload);
• a ban on domiciles outside the European Union (acquiring securities in certain markets would become economically unviable if these could no longer be held locally);
• the introduction of a minimum level of liquidity (this has not existed to date with securities and was even abandoned for property Spezialfonds in 2002);
• the valuation of assets, as well as of the fund by an independent body (stock prices would seemingly not be accepted, and this would generate unnecessary costs);
• valuations each day of trading when monies flow into or out of the fund (a daily valuation of property is not practical as it could potentially swallow any returns); and
• a ban on acquiring assets from portfolio managers who do not have an AIFM licence (a purely preventative measure that could end up cutting off institutional investors’ access to interesting investment opportunities).
It is likely that Spezialfonds would be severely affected by these regulations. Additionally, KAGs would be faced with the prospect of having to obey two competing sets of rules, as the AIFM guidelines include equity capital and other supervisory and organisational rules that already exist in investment regulations.
If the government truly intends to hamper investment opportunities such as Spezialfonds to demonstrate its proactive approach to the general public, then it should at least guarantee that people affected by these changes will be adequately compensated. A more practical measure, however, would simply be to remove of all types of funds covered under investment law from the AIFM Directive. This could be justifiable, as the regulations for capital investment groups are already covered under UCITS. For ‘conventional’ investments and their managers supervised in this manner, the use of new rules for fund managers of alternative investments are neither necessary, nor logical.
In light of the global financial crisis, the Spezialfonds has put up a good fight. It is still, rightfully, the preferred method of investment for many institutional investors. Once the economy has recovered, Spezialfonds will be able to look forward to the return of formerly high growth rates. For now though, the threat of the AIFM Directive still hangs heavy over the industry.
Till Enzian’s annual review follows the tradition started more than 30 years ago by Dr Hans Karl Kandlbinder, the originator of the Spezialfonds concept. IPE has published an English version of this report each year for over 10 years. A German version of this report appeared in August in the Zeitschrift der Gesamten Kreditwesen, published by Fritz Knapp Verlag. Till Enzian is a lawyer based in Frankfurt and advises on Spezialfonds.