German Asset Management: In the market for advice
Nina Röhrbein reviews trends in German institutional asset management, noting increasing demand for advice
Confronted with low interest rates and the need to produce returns, in a country where consultants have traditionally been a sideshow, the mindset of institutional investors has begun to change. Today, German pension funds favour investment advice from their asset managers more than the product solutions they provide.
Overall institutional business in Germany has been growing sharply. In the first half of 2012, net sales of Spezialfonds - segregated funds - for institutional investors in Germany amounted to €31bn, compared to the €23.9bn in the previous record first half of the year in 2010, according to German investment funds association BVI.
And as the next political moves and the future of the euro have become difficult to predict, the need for advice has increased, particularly when it comes to strategic and tactical asset allocation.
“There is clearly need for advice from asset managers,” says Thomas Fleck, managing director for institutional business at Union Investment. “The complexities of the markets nowadays require an accompanying adviser throughout the investment process. In addition, today tailor-made investment solutions are requested across the value chain instead of a mere product sale. Investors have also started seeking out a second or third opinion.”
Tobias Pross, head of institutional clients in Europe at Allianz Global Investors (AGI) and board member at BVI agrees: “The simple sale of products no longer appeals to German investors. As the investment environment has become more complex, they have become more interested in multi-asset investment solutions and strategic advice. Ten years ago, institutions simply bought hold-to-maturity bonds - today this is no longer an option. Instead it is buy-and-watch through the country-specific vehicles, in Germany through the Spezialfonds.”
Upcoming EU regulations such as the Alternative Investment Fund Managers (AIFM) directive, changes to the German investment law and other regulatory changes that are in the pipeline will increase the cost pressures on investors and asset managers, while Solvency II could lead to more demand for advice from small and mid-sized insurers.
Michael Fuss, head of institutional distribution at DB Advisors says: “Investors have to decide whether to continue establishing their own risk management models and asset management internally or whether to enter a strategic partnership with external experts.”
Fleck says: “Another important piece of legislation is the EU’s European Market Infrastructure Regulation (EMIR). With EMIR expected to be introduced next year, banks and insurers have to prepare for it quickly. The alternative is to simply pass this on to the asset manager, who could move over-the-counter derivatives into a fund structure to take the burden off the investor. Market volatility is another reason why many investments are returned to asset managers. Bonds, for example, were at one point easy enough to manage internally but today they are too complex for many investors to do in-house.”
According to Fleck, consultants are only involved with one-fifth of all investments. But they - like the asset managers - are increasingly called upon.
But Ferdinand-Alexander Leisten, member of the extended executive board and head of institutional asset management at German private bank and quantitative portfolio manager Sal Oppenheim, says: “We are still being asked for product solutions. However, we do have more intensive dialogue with pension funds than we did in the past and are asked to show them more alternative and tailor-made solutions.”
The German asset management market has been growing over the past couple of years.
“We have seen a constant stream of new entrants to the German market, from foreign asset managers from Denmark, the US, France and the UK, that have set up at least sales branches,” says Oliver Bilal, managing director at Pioneer Investments in Munich. “This has led to a heavily crowded market with almost an excess supply of asset management products and solutions.”
However, the widely expected consolidation of asset managers has not taken place.
The acquisition of private bank Sal Oppenheim by Deutsche Bank in 2010 was one of the few mergers in the asset management industry in recent years. However, this acquisition came about because of the bank’s distress, not because of asset management reasons.
Speculation over a potential sale of DB Advisors also made headlines this year, although it has since been announced that the asset manager will become part of Deutsche Bank’s new asset and wealth management business.
“If you going to acquire or merge at this point in time you would need to have a strong vision of what the market place will look like three years from now,” says Oliver Bilal, managing director at Pioneer in Munich. “This would require asset managers to be bold in anticipating and pre-empting the structural changes as to how distribution channels will work following the introduction of the Markets in Financial Instruments Directive (MiFID) II and how institutional investors may change due to AIFM and Solvency II. Boutiques have been growing strongly in Germany and have been able to break into some of the tight distribution networks of insurers and banks. But with banks having to increase their core capital and reviewing how they can move forward with their distribution model post-MiFID II, the directive may have a dramatic impact on the asset management industry in Germany regarding mutual funds. Therefore, I do not expect any greater M&A activity over the next 12 months. Post-MiFID II, the first players likely to make a move towards consolidation or organisational changes are likely to be investment managers that are close to commercial banks with substantial retail and private client business.”
But while there might not be a trend towards consolidation, there is a shift towards specialisation. “In Europe, I expect portfolio management and administration to increasingly split from each other and some asset managers to concentrate on portfolio management and client services, while others will concentrate on the administration,” says Leisten. “In fact, the master KAG is a structure that has derived from the increasing shift towards specialisation and the break-up of the value chain.”
It is the master KAG structure that remains the biggest driver for institutional asset management in Germany. It was established in December 2001 to allow a multi-managed master-sub-fund construction.
“The master KAG model commands the asset management value chain in Germany,” says Bilal. “And asset managers need to be clear on what they want to focus on - being either the provider of such master KAG or its portfolio manager. Asset managers trying to accomplish both, master KAG and specialised portfolio management, need to have economies of scale and scope, which only a few will be able to reach. Alternatively, asset managers need to build strategic partnerships with fund administrators specialised to manage a master KAG on a large scale.”
But both asset management structures - boutique specialists and large houses - can co-exist. Large houses have the benefit of economies of scale, while others offer specific expertise.
Investors will choose the managers whose investment style is the most suited to them. They also want long-term relationships with asset managers that have local access as well as presence in the countries they invest in.
Therefore, global presence plays an increasing role in asset management.
“Investment houses that want to grow know Germany is an important backbone but they have to be receptive to international activity,” says Fleck. “Nevertheless, it often turns out that German managers, particularly in times of stress, are better equipped to deal with the German investment behaviour and regulations.”
He estimates that around 80% of all assets under management are with Germany’s largest five asset managers.
Along with the focus on advice and solutions has come the advance of fiduciary management, the outsourcing of parts of the investment chain.
The increasing regulation of capital markets, the resulting cost pressures and the low interest rate environment will also create greater demand for fiduciary management structures.
Small and mid-sized investors who will be the first to struggle with tougher regulations and risk management are particularly likely to look at fiduciary management solutions, according to Robert Helm, managing director in charge of distribution at Munich-based asset manager MEAG.
“At some stage, investors will reach a point at which it is cheaper for them to outsource,” he says. “More investors will outsource parts of the portfolio that until now they used to do internally, such as risk controlling, reporting or asset management. We have had an increase in requests for fiduciary management mandates or outsourcing parts of the value chain over the last six to 12 months, typically from investors with under €2bn in assets.”
Fuss says: “But it is difficult to promote outsourcing in Germany. Asset managers need to be in a long-term relationship with an institutional investor, which over time can blossom into a complete fiduciary management mandate. Few fiduciary management mandates currently exist in Germany and the mandates that could be classed as fiduciary management are ones that have developed over time by gradually taking on larger parts of the value chain.”
Low interest rates and restricted risk budgets have also influenced the investments German pension funds are likely to make.
“In terms of Spezialfonds vehicles, the biggest growth in 2011 and 2012 has been in balanced and fixed income,” says Bilal. “In early 2011, German institutional investors walked out of the European periphery, leaving only a few still invested in Spanish or Italian bonds, with no one maintaining their exposure to Greek, Irish or Portuguese bonds. Instead, most investors were piling up Bunds, generally with quite long duration. This then led to another wave at the end of 2011 of diversifying into covered bonds, promissory notes and corporate bonds as well as short duration bonds across the developed markets.”
So far in 2012, investors have focused on high yield, emerging market debt and US bonds.
“However, the credit rating restriction of B- for investors covered by the insurance law VAG, such as insurers and Pensionskassen, made it almost impossible for mid-sized investors to invest in emerging market debt due to lower volumes and lack of suitable pooled funds,” says Bilal.
Investors continue to generate most of their income from government bonds. “However, domestic government bonds come with issuer and country risk and yields of 1.4-1.7%, which are too low to generate the required investment targets of 4-5%,” says Pross.
Instead, pension funds focus on a mix of high-quality sovereign bonds from euro-zone countries such as Germany and the Netherlands, as well as non-euro-zone countries such as Norway, Sweden, Singapore, Hong Kong, Australia and New Zealand. Investors stand to benefit from the growth of these countries and the appreciation of their respective currencies.
“As doubts hang over the ratings of established issuer countries, government bonds of countries such as Brazil and Poland are becoming increasingly popular,” says Fuss. “This is due to a paradigm shift in the perception of assets classes over the last 12-18 months. As a result, investors have become more open to global investments, particularly in emerging markets. Not only is the fiscal situation improving in those countries, but the coupons that are paid are also higher.”
With regard to investment strategies, anything that generates income is favoured. Ways of earning dividend without too much volatility, in other words covered strategies, have become popular, says Bilal. German investors are also interested in income-generating non-listed securities, such as infrastructure, renewables, direct property or commodities. However, with some of these investments, counterparty risk and illiquidity remain an issue.
“Investors who have a risk budget to use and do not have any investment restrictions are investing in alternatives, such as infrastructure debt,” says Fuss. “At the same time, risk overlays, liability-driven investment concepts and hedging through futures or options provide protection from extreme volatility and secure the funding levels of pension funds.”
As well as the move towards emerging markets, there has also been a shift away from benchmark-oriented portfolios to absolute or total return portfolios, which equals a larger investment universe.
“There is a trend to absolute return solutions, or the way we prefer to call it, true non-correlated investments,” says Leisten. “These should generate money-market-plus returns of 4-5%, depending on the individual risk profile.”