Eyes on the prize Eyes on the prize
Hugh Wheelan talks to German asset managers and finds the Euro is changing everything
The DM700bn (e350bn) German institutional asset management market appears to be joined at the hip to the fate of European expansion.
With the arrival of the euro the tangible shift in investor attitudes and the convergence play that began last year within the country’s larger institutions spread quickly across the institutional board.
And, both physically and philosophically, German investors have now begun to stream into the new domestic domain of Euroland and beyond.
As Michael Korn, deputy managing director at Dresdnerbank investment management (dbi) Kag, puts it: “The euro has contributed as probably the major catalyst to this investment shift.”
The resultant activity within the German asset management community to position themselves to capture the business shift has been frenetic.
Lutz Wille, managing director of Frankfurt-based Merrill Lynch Mercury Kag, enthuses: “Germany is certainly the market place where many things appear to be moving at the same time. It is quite a thrilling experience to be in the market at the moment looking to get a piece of this fast-growing cake.”
Post euro-launch, the equity strategy for most German institutional clients was clear.
Few hesitated to acknowledge the removal of currency risk and hailed Euroland as the new domestic arena.
Investment managers estimate that around 80% of their clients stepped up quickly from the 30 stocks on Germany’s DAX index to a Dow Jones Euro Stoxx 50 benchmark.
Other investors, however, retained or shifted to a Continental Europe or pan-Europe approach, benchmarking against MSCI indices, so as not to exclude the UK and Swiss markets.
Josef Kaesmeier, CEO at Merck Finck Invest, the Munich-based former subsidiary of Barclays which was sold in April 1998 to Luxembourg’s Kredietbank and directly manages DM3bn in institutional money, comments: “I was a little surprised actually because although the move out of German assets has been clear cut, I thought that most German institutions would opt for the same benchmark. This has not happened and there are still a number of institutional investors looking to MSCI indices and others seeking to invest in either small or large cap stocks mixed between euro/Europe indices.”
He believes the reason most investors stopped at Euroland though lies to a large extent with currency restrictions.
“Although these are not implicit in Germany in terms of limitation, they do act as guidelines which say that if your liabilities are in euro and you have any investment depreciation you will be called upon to explain the reasons for currency speculation.”
Over recent years the average equity portion within German institutions has been steadily climbing towards the 30% mark as the trend from bond to balanced to specialist equity mandates accelerates, according to RMC consultants in Frankfurt.
This is already becoming problematic for the country’s Pensionskassen (retirement funds) and Versorgungswerke (retirement funds for professions such as doctors and lawyers). These are covered by the BAV German insurance regulator, which sets a ceiling of 30% for equities.
As Bernd Rose, senior consultant at RMC’s Frankfurt office, notes: “Some of Germany’s large old insurance companies only have around 12% in equity, but many new Pensionskassen, Versorgungswerke and insurance companies are having difficulties with the 30% limit.”
Kaesmeier at Merck Fink adds: “Equity portions have already begun to rise, with some pension fund clients going above the 40% level and I certainly believe that in time it will head to 50% in line with the overall European trend. The BAV I know is presently examining this situation to decide whether changes need to be made to the limits.”
On the bonds side the post-euro launch picture has been markedly different .
Institutional investors are staying put in the relatively stable territory of the 10-year Bund, which ostensibly remains one of the euro benchmarks by virtue of its size.
“German institutional clients are talking about a eurobond shift but don’t see a suitable benchmark so they appear happy for the moment with the REX benchmark that has dominated the German market for the last 10 to 15 years,” says Kaesmeier. “It is surprising because it is a very tough benchmark and the average coupon of the benchmark is more than 7% and you can only get about 4.5% at present. All the new European benchmarks have a longer maturity because they include 30-year bonds, but this is a bit excessive for many German investors who remember being badly burnt by rate rises in the eighties on 30, 40 and 50-year bonds bought in the sixties.”
Nevertheless, lower interest rates have meant disappointing premiums for insurance companies seeking the minimum return level on contracts of 4%, which for new clients is being lowered to 3.5%–so the search is on for higher yields.
The mortgage bond/asset-backed securities Pfandbriefe and Jumbopfandbriefe market has remained strong, with institutions keeping faith with the strongly regulated, mostly AAA issues, where yields are slightly higher than in Bunds.
But the hot topic for German institutional investors at present is undoubtedly the advent of the European corporate market.
As Peter Schwicht, managing director at Frankfurt-based JP Morgan Investment, notes: “The interesting issue is how the credit market is moving away from just the AA known names. Lower credits are becoming available and I think in three years we could have a totally different bond landscape.”
However, the market still appears to be split between the average risk-conscious German institution and the more sophisticated multinationals and larger pension plans.
Hans Peter Strubreiter, CEO at Munich-based Bayern-Invest Kag, the 100% owned subsidiary of the Bayerische Landesbank which is in turn half owned by the country’s savings banks (Sparkassen) and the Bavarian state government, managing institutional assets of DM24bn in 145 Spezialfonds, says: “Clients are very risk-minded here and even if the yield is 500 basis points higher with corporate bonds, if they are not above A-rated they still tend to be ignored. There is a need for experience and knowledge about defaults in this field before fund managers allow themselves to be more risky.”
Nevertheless, Kurt Hauner, head of consultancy at Frankfurt-based Towers Perrin, comments: “We are already seeing credit investment going down to the BBB level.”
One trend at the moment for German institutions seeking credit exposure is investment in US corporate bonds hedged back to the euro.
Norbert Enste, partner at Frankfurt-based Metzler Asset Management, running approximately DM14bn in institutional assets, of which DM12bn is run via the group’s 76 Spezialfonds, explains: “Corporate bonds and asset-backed securities and all the segments of borrower quality up to high-yield bonds are developing quickly in Europe, but so far – unlike the US – there are no broad segments in every credit class, which doesn’t allow the construction of well-diversified portfolios. So how to manage credit is really something that German investors can learn from the US.”
For the time being alternative investment in Germany is limited but gathering momentum.
Rose at RMC comments: “We have clients who are using private equity and this ‘new asset class’ must necessarily be integrated and controlled in a strategic asset allocation and also depends on the total volume of assets within a fund. On the derivatives side I still think this is too much of a tactical decision for most German investors, although some are using hedge strategies to protect against downside risk.” Since April this year income from derivatives is now also fully taxed.
Rose notes that emerging market investment is a similar strategic issue and any bets are very small.
The developing German investment market has also brought on the issue of passive management, although uptake for indexation is still very low at around 3% of total institutional assets.
But Wolfgang Hötzendorfer, head of Munich-based State Street Global Advisors (SSGA), Germany, which started its Kag in September 1998 and currently manages around DM4.2bn in assets, believes the time is right. “Passive management in the German market is just starting and the really large pension funds have index portfolios as part of in-house or external tactical asset allocation provision. However, I can see the passive market share rising to 30% in the next three to five years. We have seen the same development all over the world because of the increasing accent on safer performance, so why not in Germany?”
Michael Korn at dbi concurs: “It will only be a matter of time if the market starts to boom before indexation is firmly on the agenda and consequently we are certainly looking at whether we want to make it part of our future core business.”
Christian Mosel, head of global marketing at Frankfurt-based Commerzbank Asset Management, is not convinced. “We are not really expecting a massive surge in passive management because the price you pay for active management is 10–15bps so you only pay 10 more points than for passive and benefit from the potential for outperforming the market.”
He concedes that the issue of fee substance is paramount here and says foreign asset managers are still surprised when they offer management fees of around 60bps compared to the low asset management fees of their German counterparts. “It is still one of the major hurdles for foreign managers in the German market,” he says.
However, Von Knebel at Baring believes Germany has now arrived at the point where a number of different streams are swelling the professionalisation flow. “The euro has opened up the issues of transparency and best execution and along with consultant input and the advent of GIPS standards the market is moving forward swiftly.”
And Alan Crutchett, managing director at Frankfurt-based Schroder Investment Management, adds: “ I’m particularly surprised at the speed of change in the consultancy business where there was very little happening until recently.
“The trend is now definitely towards using advice and it is very much a question of transparency, investment accountability and Spezialfond reviews.”
Hans-Jürgen Reinhart, partner at RMC, consultants with offices in Cologne and Frankfurt advising for approximately DM12.5bn of pension assets, explains that German investors are now seeking a comprehensive advisory approach. “We take the client from the starting point of asset/liability questions and offer all the investment processes in the value chain up to the manager search. This is very important in Germany because the market for asset management consultancy is still very much at the beginning and the need for advice in structured asset management processes is obvious.
“We think there is a big difference between the way that German clients approach risk tolerance compared to Anglo-Saxon investors, because the focus is principally on downside risk and in so far a classical asymmetric risk-profile. Such cultural differences alongside the language issue appear to have been a problem for the Anglo-Saxon consultants.”
Patrik Roeder, managing director at Frankfurt-based Deutsche Asset Management, adds: “Surprisingly it is the German consultants that are succeeding at the moment and perhaps even doing a better job. I’m not sure if the Anglo-Saxon consultants fully understand the German market yet.”
Kurt Hauner at Towers Perrin, comments: “We are dealing with a conservative market but it is open to ideas and we are optimistic about future growth in the business. Certainly there is the need to have local staff and in-depth market knowledge.”
The consensus in Germany is that such change is eroding the traditional “Hausbank” investment approach as clients look to garner specialist expertise, best execution and clearer fee structures. Consequently, many of the large German players are having to change tack.
Dieter Wolf, CEO at Victoria Kag, “The unbundling process began around two years ago and I believe this will follow the Anglo-Saxon model in time.”
However, Roeder at Deutsche comments “ I think it would be wrong to say that German clients were paying too much for fees in the past because the brokerage commission was high. Nevertheless, I fully support the need for transparency. The asset manager, broker and custodian should be paid relatively for the importance of the job they do. New clients here are certainly tending to go down the unbundled route that we now offer.”
Strubreiter at Bayern Invest says clients are still asking for the bundled approach though. “Asset management in Germany is still a very discreet business and there is a very close relationship between the client and asset manager, therefore they often look to keep all the business together. Competition in the market has brought down transaction fees from around 30bps to 15bps on equities and there is still a need for a German-registered custodian which has traditionally been carried out at no charge by the banks. The bundled approach is still the case for 80–90% of our German clients and I believe this could take a while to change.”
The substantial compound growth rates over recent years in the Spezialfond market, which tempted the foreign asset managers into Germany are still keeping business buoyant, but as Hauner at Towers Perrin notes “relative market share for the foreign managers is still low”.
He acknowledges though that they are “pushing hard” and believes the increasing overseas investment could benefit them.
Frankfurt-based Credit Suisse Asset Management (CSAM), in Germany since 1987, currently manages DM5.5bn in institutional assets of which DM1.5bn is managed using advice from the group’s global resources via New York, London and Tokyo. Edgar Weissenberger, CEO of CSAM Germany, says: “There is a trend towards global mandates from the larger funds and going forward we have to sell our global capacity such as in US equities and high yield bonds or emerging market debt as a competitive advantage to win German business.”
For the big domestic banks and insurers though, the business focus is now unequivocally shifting to Europe and beyond with group investment strategy and product lines transforming accordingly.
Michael Korn at dbi, managing DM80bn in German institutional money through its Spezialfonds from a total of DM180bn in overall assets under management within the group, says it will announce a new global asset management structure this month bringing together product and distribution.
“We are certainly in the process of seeing how we can develop our German distribution, but Europe is the challenge now.”
Closer integration he says will occur between dbi and Dresdner RCM which currently manages the group’s specialist investment side in high risk alpha with dbi carrying out the low risk investment which focus on consistency of long term performance.
Patrik Roeder at Deutsche, which has German institutional business of e40bn, explains that the group’s operations will all be coming under the Deutsche Asset Management banner this month.
“The desire is to have one name with a clear investment philosophy and broad product range world-wide. The former Bankers Trust arm will significantly strengthen our US and Japanese investment. Marketing and sales will be done on a regional basis split in Europe between London for the UK and Frankfurt for the rest of Europe.”
The group will also open an office in the Netherlands later this year to move into the Benelux market and the French market is also firmly in Deutsche’s sights, Roeder says.
Commerzbank, with assets under management of DM230bn has a different expansion philosophy, as Christian Mosel, explains: “Our policy has been to buy into very profitable, well established businesses and we believe it is optimal to retain these brands as such in their domestic markets. We are looking at the issue of central steering within the group and branding our subsidiaries and affiliates as ‘part of the Commerzbank group’ but believe that people understand the purpose of our set up.”
The group is currently focusing on the Spanish and Italian markets where offshoot Promodori has recently begun selling mutual funds, says Mosel.
And Munich-based insurer Allianz has just created a new Luxembourg-based institutional umbrella fund in what Markus Riess, CEO at Allianz Asset Management terms: “the desire to become a serious pan-European player”.
Tina Wilkinson, head of product development at Allianz, explains: “This Luxembourg-based master portfolio platform integrates our global investment process and allows us to clone our flagship investment products for the European institutional market. Cloning permits us to easily construct products cost efficiently within different legal structures to respond to the varying needs of institutional investors while ensuring consistency in the process and product.
“For the medium size part of the German institutional market where investors typically would not have a Spezialfond or may not want to set up a specialised mandate, we will have the Luxembourg product to capture this business. We will hopefully be registering this product soon on the Munich and Luxembourg stock ex-changes.”
All eyes, however, are focused on how the future German pensions terrain will look, particular in light of recent signals from the German government that it is seeking grapple with the issue.
Since their legal ratification, the flexible Altersvorsorge Sondervermögen (AS) mutual funds, championed by the German BVI mutual fund lobby group, have been growing steadily –much to the surprise of fund managers who doubt whether they can be really successful without the application of tax incentives.
Wolfgang Raab, head of the pensions/savings department at the BVI, notes: “The reality in Germany is that companies have been more and more reluctant to offer occupational schemes to their employees. AS funds, which are ideal for DC systems, could change that. Initiatives such as the Daimler Chrysler AS funds, where the company has negotiated to have no front-end fees with asset managers and which are economically efficient and portable for employees to save for their retirement, are already proving to be a success.”
And Korn at dbi, one of the managers selected to run assets for Daimler Chrysler, adds: “This has begun to give the DC push a certain eligibility in Germany. Up until now there were technical difficulties with running DC schemes, and it would still help to be able to get the legal advice.”
Peter Scherkamp, CEO at the Mu-nich-based Siemens Kag believes the company’s open-ended mutual fund programme for private retirement savings schemes for employees can be easily modified to support future government initiatives with regards to tax advantaged DC schemes.
“The model we have developed for Siemen’s employees is a simple investment approach in European blue-chip equities and high quality bonds with transparency through our intra-net connections. It can be replicated anywhere.
“We have the expertise in asset management and can offer this at a good price to our employees because we have less in the way of marketing costs. Siemens’ technological background will also keep us abreast of the business opportunities ahead through e-commerce in this area.”
Scherkamp adds that Siemens Kag sees its responsibility to assist and advise in the development of schemes for corporate pensions management including company sponsored em-ployee programmes for personal retirement planning. “I believe we are a special animal in the pensions area in that Siemens comes from the industry side with deep experience in complex pensions issues on a global scale. We have first hand experience that could benefit other parties in discussions concerning the very important and urgent pensions issues facing German business today.”
The overriding question in investment managers’ minds is whether the route ahead – will be via this pooled solution through company/industry pension funding or whether Germany will see individualised forms of savings on the US 401k line.
Peter Schwicht at JP Morgan Investment, comments: “Obviously with our DC record in the UK and US we are looking at the developments here with great interest. The big question will be whether this development comes via the employer where they carry out the administration and specific accounting. If so the number of potential players in the market will be great. Should this become the burden of the asset manager then it changes the game altogether.”
Lutz Wille at Merrill Lynch Mercury concurs that any administration onus on the investment manager may favour the German banks and insurers. “In such a case it would be preferable to offer a bundled approach to the business where you have the size and resources to do the whole package, right down to the weekend hotline. What we may see happening here is some kind of partnership on the administrative side, because we still believe we can compete in this business.
“Certainly this is a time where everyone in the investment management community is talking to everybody else, and at the very end before contracts are signed it could well be that we may see some surprising new alliances shaping up in consideration of historically close partners in the investment business. There may be tough decisions to take such as cutting historical links with partners. It is something which will take time.”
However, nothing is certain about Germany’s future pensions direction as Peter Koenig at Morgan Stanley in Frankfurt, points out: “AS was a nice move by the investment industry in Germany but it could turn out to be history if we get a 401k arrangement.”
He adds that Morgan Stanley is optimistic about the future market potential and currently considering its own strategy for managing German institutional assets.
Deutsche’s Roeder expects a hybrid system to be the way ahead: “The German people and the unions still expect a pensions guarantee, so I don’t see pure DC schemes on the horizon in Germany.”
But as Von Knebel at Barings suggests, the savings shortfall in Germany is acute: “A tenfold increase in pension savings would be needed over the next 10–15 years to bring the average German saving per person of DM4,800 up to the US level of an average of DM38,000 per person.”
Going forward there are few doubts amongst the German asset management community that the demands of capturing such business allied with the sheer cost of maintaining quality asset management provision will shrink the market.
As with the rest of Europe, most concur that Germany will split between the “large and powerful and the small and beautiful”, says Patrick Roeder at Deutsche. And Dieter Wolf at Victoria Kag predicts that the institutional market will only consist of around 50 Kags within five years.
Certainly the potential prize at stake in the German institutional market is enormous. But the overriding question from asset managers now is when, not if the German government will take the political plunge and address the pensions time bomb ahead.