Pooled funds have ceased to be the poor man's investment tool as more investors in Europe are waking to the fact that funds have a full role to play in their portfolios
Costs do dictate. Pooled funds have become the domain of small to mid-sized pension schemes, not to enable them to access difficult areas of investment such as emerging markets, but for their fiscal advantages. As segregated mandate minimums rise to meet underlying costs, schemes are turning to the only other viable, affordable alternative.
In Germany, Spezialfonds 'fever' was marked by the explosion of assets under management to DM549.6bn ($305bn) last year from DM389.5bn in 1996, with 51% of this figure accounted for by corporate pension funds and insurers. And tax incentives have enabled offshore fund domiciles to retain their appeal, with Guernsey reporting a 15.7% increase in 1997 in the number of new funds domiciled in the jurisdiction and Luxembourg's total number of funds and sub funds rising by 16.39% to 4,550, according to a Fitzrovia report.
In France and Belgium, pooled vehicles have cornered the institutional market for reasons of tax efficiency. The $25bn Belgian pensions market in particular uses pooled funds on a mass scale. The majority of pension schemes themselves are fairly small and are unable to diversify their assets via a segregated route with the current sums in their portfolios, giving pooled funds a virtually captive market.
As well as achieving broad diversification, SICAVs and their Belgian equivalents, BEVEKs, have essentially held a fiscal advantage for Belgian investors who can avoid the 25% capital gains tax on all equity investments and 15% tax on all fixed income returns, which has sustained the funds' popularity to date.
Out of the Bfr116bn of institutional assets managed by Kredietbank, the country's largest mutual fund pro-vider, approximately 25% is invested via pooled funds. And now institutional funds are being set up for pension fund investors to give them the transparency unobtainable from a retail fund (see page 44).
The larger schemes however remain heavily biased towards the direct approach, for reasons of being able to dictate investment policy. UK-based Hermes Investment Management, which runs the Post Office and BT schemes, follows the traditional approach of only using funds for areas of investment such as emerging markets where good diversification is difficult with a segregatedaccount and where a pooled fund offers a second layer of liquidity in markets where the liquidity is low.
The cost issue will evidently not be such a driving factor for larger funds such as Hermes, but the Dkr17bn ($2.5bn) Danish pension fund for engineers which invests in US small caps via Schroders' Luxembourg-domiciled umbrella SICAV can see the clear advantages in going pooled. It is a matter of admin and practical cost issues that would decide whether we want to do it one way or the other," says Steen Villemoes, director of investments. And while the fund accounting angle is an obvious selling point for small schemes, Villemoes applies the same philosophy to his own larger scheme. "If we have invested in a fund it's only basically taking one line in our accounting books, whereas if we have a seg regated portfolio we have to register all the individual transactions in the portfolio."
Furthermore, the Skr3bn ($400m) Nobel Foundation fund has committed 50% of its equity allocation (equities account for 60% of the entire fund) which is now invested in pooled fund vehicles, a move taken on the basis of liquidity and structure. Åke Altéus, the foundation's deputy executive director, admits the segregated ap-proach allows investors to set investment terms but he is more concerned about the end results than the actual path taken to get there.
Not forgetting the move to defined contribution combined with the search for a pan-European pension fund, multinationals are increasingly looking for ways to unify their subsidiaries' investments; pooled funds are the only existing vehicles that make viable and economic sense. One European multinational company is investigating the possibility of using pooled funds as a route to unifying its European subsidiaries' investments.
While the EMU question is a major factor holding up the process, the company's idea centres on the UK scheme, which is substantially larger than the rest of its European subsidiaries put together. It is looking to see if it could establish some pooled vehicles in a tax-friendly environment where its European funds could buy investment management on the back of the size of the main fund.
Pooled funds have traditionally serv-ed the needs of all sizes of pension funds who want to dabble in asset classes such as the emerging markets, and small funds that cannot afford the ever-increasing mimimum set by discretionary portfolio managers. But the pension fund industry is now feeling another push - from the custodians.
The custody function, some believe, will become increasingly influential in driving more and more funds down the pooled fund route. Until recently, investment managers have given custodians a "parcel" of the smaller pension fund clients. The custodian has had to look to the underlying fund for the risk involved in settlement or turn to the management company which may not be in a position to provide the capital required to "back up" the total assets. More and more, custodians and managers are saying they need to contract directly with the underlying fund and in the process the underlying minimum has been steadily increasing.
In essence, smaller funds are being forced out of the segregated route and pooled funds are waiting in the wings for them. "The pooled route is increasingly going to become the route to which even medium-sized pension funds resort," says one observer. "Basically everything under $100m.""