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IPE special report May 2018

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Liam Kennedy discussed the investment philosophy of Germany's VolkswagenStiftung with its CIO, Dieter Lehmann

Compared with its counterparts in the US, where newspapers have reported grant and personnel cuts at some of the leading foundations and endowments, Germany's VolkswagenStiftung - or Volkswagen Foundation - made a record sum in grants of more than €120m available in 2008. This was well above its self-imposed target of €90-100m per year.

This success can partly be ascribed to the investment policy the foundation has chosen for itself and partly to domestic legislative requirements for German foundations.

First, the aims of a German foundation in the area of asset allocation are somewhat different to those in other countries, as VolkswagenStiftung's chief investment officer, Dieter Lehmann, makes clear (see panel, How does a German foundation invest?).

"The level of grant activity has not come into question due to the financial and economic crisis," assesses Lehmann. "Of course, if we experience in 2009 a similarly bad year as in 2008, with similarly high accounting provisions, we would then have to lower the grant sums somewhat in order to increase them in later years. But this probably will not be the case."

The VolkswagenStiftung itself, based in a leafy suburb of Hanover, has an academic feel about it that is far removed from the modern Volkswagen plant some 80 kilometres eastwards at Wolfsburg. Dieter Lehmann runs the investment department from a modern ground floor office.

The roots of the foundation are, of course, intimately tied to Volkswagen. It dates back to the part privatisation of the Volkswagenwerke in the early 1960s when the newly established foundation received DM1.5bn (€550m) resulting from Volkswagen's conversion to a joint stock company. The foundation funds academic research in a variety of fields, not just in the areas of technology or natural science.

Following the sale in the 1980s of the Federal Republic's 20% holding, the foundation retains the right to the dividend income from the 20% holding of shares held by the State of Lower Saxony.

In terms of governance, the overall responsibility for investment rests with Dr Wilhelm Krull, the secretary general of the foundation. The day-to-day responsibility lies with Lehmann.

The 14-person Kuratorium, or governing body, jointly appointed by the Federal Republic and the State of Lower Saxony, is the first-line decision maker concerning grant activity and formally approves the accounts. It receives a report annually about the investment of the assets, which forms the basis of the grant-making decisions since this determines the level of capital it has at its disposal. It also decides the global strategic orientation of the investment policy.

An investment advisory body consists of five persons, chaired by a member of the governing body (currently Prof Martin Hellwig, director of the Max Planck Institute). The other four members provide different perspectives on the financial markets by way of their background. There is a representative of a large bank, a small private bank, an insurance company and a CFO from a large industrial company.

"The nature of this body is purely advisory. It meets twice a year, and Dr Krull and I participate," says Lehmann. "My part is to report on our activities, the ideas we have and perhaps the new products that we are using, as well as the risk we are running, the model calculations, the investment report, and the plans."

In autumn a plan is presented for the coming year: "This is reported to the investment advisory body and it makes recommendations. For example, its opinion on the results of the previous year - whether it was good, what one could have done differently, and gives recommendations on different groups of products."

However, the advisory body makes no decisions and its recommendations are officially made to the secretary general, who has formal responsibility for the investment management, although this is formally delegated to the head of investments for the day-to-day operations.

The investment department was founded in 1989. A seven-person investment team is divided in terms of its responsibilities into equity (with private equity), fixed income (with hedge funds) and real estate.

The foundation was an early adopter of real estate and began to invest in equities in the late 1980s. The larger part of the portfolio - some 60% - including most of the fixed income investments, is now internally managed. Real estate is invested externally, although decisions regarding sales and purchases, rental contracts and renovations are made internally.

All equity investments are made passively and the majority internally, tracking the Dow Jones EuroStoxx 50 index. A further equity portion is also invested passively, selecting the 10 highest income generating stocks from a combination of the Dow Jones Eurostoxx 50 and the domestic DAX index. Although this custom portfolio is only rebalanced once a year, Lehmann regards it as a passive investment.

Non-euro equities are invested externally. This area has been rationalised to two passive external Spezialfonds. One contains sub-portfolios managing US and South East Asian equities; the other manages sub-portfolios of Japanese, UK, Swiss and Scandinavian equities.

The foundation does not exercise its voting rights as a passive investor. Sustainability is a concern, however. "We have analysed our equity universe to determine how many companies comply with a range of sustainability criteria and found that 67% do so."

Lehmann continues: "We are trying to understand these concepts, not in order to reject them but to assess them thoroughly in order to work out whether we can utilise them. We try to do this on a global basis, in order to remain credible and not just to buy a sustainable fund."

In the area of alternatives, Lehmann says the foundation has become more sceptical. The VolkswagenStiftung uses a Spezialfonds to invest in around 25 single hedge funds. Distressed strategies are excluded, however, as this does not comply with the foundation's ethical beliefs, since individual investments could result in mass redundancies.

Lehmann says he is thoroughly disappointed with the performance of the foundation's hedge fund investments, even taking into account the short-selling bans and margin calls from prime brokers to which the industry has been subject.

"The hedge fund industry claimed in unison to live from market volatility. They had that in heaps in the last year but they were not able to generate performance from it. I often hear the argument that this has worked in terms of diversification since hedge funds performed worse than fixed income but better than equities. This is true, and the opposite was the case in the previous year. But in terms of the requirement for total returns, they are absolutely not justified in terms of their fees. And I am disappointed."

He continues: "The 2000-02 period led to a mystification of hedge funds; it was a time when they had double figure performance. It is astounding that they have not been able to achieve that this time." And there is also the suspicion, Lehmann says, that some funds were not really acting as hedge funds.

"When asked concrete questions about their strategy here at our table, some said that they would not answer. We terminated these conversations immediately because we have no intention of throwing our money into a black hole. This overbearing arrogance has led to the intransparency that we have experienced.

"I believe that regulations will be applied, whether justified or not, and the hedge fund industry will not be able to avoid them. We are going to ask ourselves whether hedge funds are still attractive or whether we will exit this segment."

But while Lehmann is happy with the level of transparency in the foundation's own hedge fund investments, he believes the promises concerning transparency and reporting have not been fulfilled in the area of private equity. The VolkswagenStiftung has two private equity mandates - a US buyout programme and a European secondaries programme, invested through certificates, due to German tax rules.

Nevertheless, he recognises the need to take a longer term view: "We have had two mandates since 2006 and they have not performed very well, although three years is a short period and we must give them more time as you need that time to evaluate the asset class."

But Lehmann is sceptical regarding further investments in private equity: "I am not certain about how to assess performance in future, he says. "The problem with private equity is that it has also made promises of high performance. The talk is always of top-quartile performance but the curious thing is that I have never met anyone in the second or third quartile. This top quartile promises returns of between 10-15% per year but the point is that these performance numbers are calculated from actual committed capital and I cannot understand this. Some have less than 50% and others over 90%.

"When I agree a commitment sum I must hold virtually 100% in liquid assets in case the capital is called. That is the point when we start to ask, what does this investment bring us?" continues Lehmann. "There is also the extra cost involved with the certificates, and the foundation has used its entire allocation to purchase the certificates. The performance is related to the price of the certificate, not the actual private equity commitment.

"When I take this into account, I have to forget these fantastic performance numbers, and in our case we are at performance not too far removed from fixed income. We will have to look at that over 10 years, but so far it has not brought us much. The private equity industry does not do itself any favours and it is not fair to inexperienced investors.

"The private equity industry should also be cautious about what happens when the knowledge, sensibility and know-how of investors grows. The providers should be aware that they depend on the money of the investors and not the other way around because their industry will end if the flow of capital ends."

The authorities of the State of Lower Saxony are the contact point to clarify legal questions as to the permissibility of investments such as alternatives. They have determined a limit of 10% for investments that do not generate ordinary returns. The foundation would consider increasing its alternatives quota in conversation with the authorities.

While US foundations have been heavy investors in areas such as timber or commodities, the VolkswagenStiftung has not made investments in these areas.

The foundation recently compiled a dossier of investment opportunities that it does not currently use, to determine what might have changed as a result of the financial crisis. Among the opportunities are Latin American equities, although this question is at the extremely early stages, and any considerations would be made internally first. Another is microfinance, but one problem is that indices are not available. The question is whether such investments achieve real diversification.

"In terms of other investments, this is an ongoing activity and we are permanently concerned with the question of how to diversify our investments further or perhaps better," says Lehmann. "We are not in any hurry. Our assets are very well invested in my opinion and time pressure is a poor adviser when it comes to investment."

Rather, Lehmann is concerned with how institutional investors will operate in a changed world in terms of risk control and the many ways to calculate risk, "Every basis for calculation, whether value-at-risk or volatility, all represent a certain probability of my risk potential and does not predict what will occur," he says. "There are further questions: how strictly must I adhere to the risk budgets? If I establish stop loss limits according to the basis of risk budgets, does this make sense or would it be negligent? Do I sell in market down phases because a risk budget is exhausted, and then realise the losses, or do I sit out the down phase?"

Lehmann concludes: "I don't have an answer to these questions, but in light of the financial and economic crisis, I find them much more important and interesting than whether I should invest in commodities or not."
 

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