In at the beginning
The surprising thing about Universal Investment, which is leading the master Kag revolution in Germany, is how long the KAG has been around. “We were formed in 1968, coming from a private banking background,” explains Bernd Wagner, managing director of Universal in Frankfurt. Five German private banks are the shareholders, Baden-Wuerttembergische Bank, Bankhaus Lampe, Berenberg, Hauck & Aufhaeuser and Merck Finck.
But even then, it was set up purely for accounting and administration purposes combined with the advisory function of external asset managers. “We act as administrators for both retail funds and institutional Spezialfonds.”
For many years, the assets it looked after hovered around the E8bn mark, but in the last seven years this has shot up sharply to around E33bn currently. “And we have up to another E7bn in the pipeline.” This makes it market leader by a good margin other groups focusing on the administration business – a position Wagner feels “very comfortable” with.
So when the outsourcing debate really took off in Germany with the green light from the supervisory authority in 2001, Universal was able to present itself as the pioneer of the outsourcing of portfolio management. “This was especially the case for foreign asset managers wanting to operate in Germany.”
But well before this official move, the KAG had launched its first ‘multi-manager’ Spezialfonds mandate in 1990. The original concept came from a German institutional client who suggested having an advisory mandate on a segmented basis for an international manager who did not have a KAG operation in Germany.
“Nowadays, this would be called a ‘master fund’, whereas then we called it a ‘Segmentfonds’.” With this structure, the group provided a single Spezialfonds that was compartmentalised, allowing the investor to have a number of different asset managers managing different portfolios, yet having all the accounting and other benefits of the Spezialfonds. This key step, meant investors could consolidate all their assets within one structure, rather than have to set up a new Spezialfonds whenever a new manager was appointed.
This was of particular interest to foreign managers, as investors could appoint them on a sub-advisory basis. Wagner reckons the KAG has acted as the conduit for over 120 asset managers worldwide to service pension funds, insurance companies and other institutional investors in Germany. “This list reads like the ‘who’s who’ of the business.”
“So in the last decade, and especially in the last five years, we have learnt how to develop this new structure, ” he says. “We made many sub advisory agreements with these asset managers, in what at the end of day, could be regarded as a purely outsourcing arrangement.”
The basis on which it formally worked was that the KAG was responsible for the Spezialfonds structure established by the investor and had to make sure that all aspects of the sub advisory mandate complied with German law. “So Universal would accept this, but had an agreement to outsource the asset management to a manager in London or New York.”
It was the beginning of this year that Universal made its two first full blooded outsourcing contracts. He describes the main difference between the earlier advisory approach and new outsourcing basis: “With advisory agreements we have to exercise our control ex ante or before the transaction takes place, so that when we get the portfolio recommendation, we check it against legal investment limitations and internal guidelines, for any restrictions and so on, then we channel the order to the broker or back to the asset manager to execute. In a typical outsourcing agreement, we have ex post or after the event controls, so the asset manager can execute the order, but then one day later give us a list of transactions, which we check for compliance with legal investment limitations and internal guidelines.”
The supervisory authorities agreed to this in December 2001, in their now famous official notification to the market, which is now enshrined in the proposals of the new legislation coming into force next year, covering outsourcing along with a range of other issues.
Wagner says the real start of the group’s growth in the administration area was over the last six year period when assets grew from E8bn to over E33bn. Most of this growth was from the Segmentfonds/Masterfonds area. The clients for these products is a list of the German institutional marketplace such as insurance companies, Pensionskassen and contractual trust agreements”. He adds: “In this period, we have had no institutional sales activities of our own for this sub advisory business, the rise in the market was driven by its own momentum – it ran by itself.”
However, over the past year it has seen other groups move into this market and there are “some more big elephants in the pipeline”, as he puts it colourfully. “But we are quite relaxed about this competition, as we are the only KAG for whom the master KAG is the core business. For the others, the concept is just an add-on business.”
He agrees that Universal probably acted as an important safety valve over the past decade by providing an alternative route for foreign asset managers wanting to source German institutional assets, but not wanting to set up their own KAG.
The outsourcing change though only a small change in the functioning of the client/KAG relationship, will have enormous structural impact on the market, Wagner believes. There are some 85 KAGs operating in Germany, many with less than E5bn under management and they face a momentous choice: “They have to decide to be an administrator or an asset manager over the next three-to-five year period. For these smaller KAGs, deciding to specialise in asset management, we can be the insourcer for administration.” But Universal wants to extend its platform to cover discretionary accounts. “So clients will have the choice of managing through mutual funds, Spezialfonds or in discretionary accounts.” The group has to provide all the services required in terms of performance measurement, attribution and risk analysis.
On the much discussed question of the future of Spezialfonds, Wagner is sanguine, believing that they still have considerable advantages for typical German clients for the foreseeable future. “With the new law, we will see hedge funds initially come only – at the beginning – within a Spezialfonds structure for institutional investors, while retail investors must use funds of funds. So that’s only one example and I certainly do not see an end to these funds in Germany.”
There has been discussion as to whether Spezialfonds should be covered by the investment law at all, but as some E500bn is invested in these vehicles, Wagner finds it hard to see how they can ever be outside the legal framework.
As to the development of discretionary mandates, he points out that there are no figures available, so no one knows the amounts in such accounts. The real issue for investors is the extent of the services being offered whatever vehicle is being used. “For the institutional client, to implement risk and liability management, the master fund is an excellent structure, so that all the control is handled by just one KAG and one global custodian.”
He does see the question of global custodians moving into offering directly master KAG services as a threat longer term. “That is certainly a danger,” he says. But under the Ucits fund legislation as applied in Germany, fund accounting cannot be handled by the global custodian. “We have a system of parallel controlling, so the KAG has responsibility for compliance as does the custodian. This double check system has worked well in Germany for the past 40 years.”
In addition to working with over 20 local custodians, Universal reckons it is the only KAG which works fully with the four global custodians active in the market: JP Morgan, State Street, ABN AMRO Mellon and BNP Paribas and there should be a fifth when the Bank of New York comes into Germany in partnership with ING. “The pressure is coming from the bigger institutional clients who no longer want to work with smaller custodians, and want just one master KAG and one custodian with a worldwide platform. This will apply not just to Spezialfonds but any discretionary accounts as well.”
As a consequence, a pan-European platform could the be developed, which currently is being held back by local patchwork of legislation, resulting in the fragmented marketplace. “But step-by-step there will be more harmonisation in Europe.”
Looking ahead, he sees ongoing changing in the marketplace, but change is not a problem in itself – it is the speed at which it happens. He points to the move from advisory to outsourcing in some respects has been no more than a ‘hair’s breadth’ change. “In the past, some industry colleagues here and there predicted the end of Universal assuming that the supervisory authority would ban our practised procedures regarding advisory. But as we can see, now it has gone completely the other way and it seems to be just the beginning.”
The group focus will be concentrating on the services to institutional clients and mutual funds clients. The area of pension administration is not appealing to it largely due to the heavy retail and fragmented nature of the market. “There are different ways of providing pensions in Germany and any platform will have to cover all these different ways.”
Universal’s priority is to maintain its leadership in its chosen sector. “With our new and better IT system and greater straight-through-processing, which are in the implementation phase, we hope to increase the volumes we cover to perhaps E50 or E60bn in the next three years. So our target should be to become one of the five or six largest administration platforms in Germany working with the largest global custodians, with a big market share among institutional clients.”