For some German asset managers, the big disappointment of 2004 has been the lack of any big picture of how the asset management industry might develop in Germany. The prospect of an Anglo-Saxon-style consolidation seems as far away as ever.
Meanwhile the current shape of the industry has not changed significantly. Although some foreign asset managers, notably Wellington, Capital and Fischer Francis Tree & Watts, have acquired substantial business in Germany in the past two years, the bulk of assets are still in the hands of large domestic players such as Deutsche, Allianz Dresdner, Cominvest and Deka.
Partly this has been because the capital markets have failed to deliver the recovery that seemed to be promised of 2003. Partly it has been because institutional asset management activity has been so muted – only E4.7bn of new money flowed into Spezialfonds in the first six months of the year.
The result is that asset managers and their clients have lowered their sights. Andreas Krebs, managing director of Commerzbank Europe (Ireland), says that asset managers are now returning to technical issues such as the impact of IFRS reporting on Spezialfonds:
“For the past two years we have been talking about the technical parts of the business - catching up with Anglo-Saxon processes, using investment consultants, and seeing the master KAG as a chance to employ foreign-based managers.
“At the beginning of this year the institutional investor had strong hopes that with the recovery in the markets a more optimistic mood would return. But there has been no significant upward trend in the markets. So we are left again looking at the technical side of the business.
“Institutional investors are now talking about restructuring their existing mandates rather than new trends or favourably developing capital markets. They are concentrating on streamlining their asset allocations, streamlining their set of managers and optimising, monitoring and seeking to add, step by step, the new asset classes to their portfolios.”
Yet some broader features of the German asset management landscape are changing. The Hausbank relationship continues to lose its hold on institutional clients although many are still in its grip. Rainer Schröder, managing director and head of sales at Invesco in Frankfurt, says: “There is still the occasional institutional client that more or less openly lets us know that we are competing against a Hausbank that offers loan facilities, which is important for companies, especially industrials.
“So if we are talking to a treasurer of a corporation they will know that we don’t offer loan facilities but that our competitors do. It’s something we can’t compete with.
“Yet the incidence is decreasing because the standard model is not any longer that of a bank that does asset management just as an addition to its custody business. The model is changing, and institutional clients are becoming increasingly active in selecting the components of the business they need, whether it is custody, administration or management.”
Klaus Eswein, managing director of State Street Global Advisors in Frankfurt, says: “There is a move away from this kind of ‘closed shop’ business relationship, because it doesn’t work any more. The tendency of investors, mostly coming from industry but also from pension funds linked to a single corporation or a sector of the industry, has changed the thinking in this direction.”
Stephan Romer, head of institutional business development for Germany, Austria and Switzerland at SEI Investments, says investors are turning their backs on Hausbanks in their search for ‘best of breed’ managers: “You can see a trend away from a Hausbank relationship. Clients are now more product-oriented. They want to ensure that they get the best products that are available and they want access to the best managers.”
This offers an opportunity to asset managers offering multi-manager structures, he says. “For small- or medium-sized institutions the key challenge is first to identify the best managers and then to access them. So instead of direct advice from consultants, or individual searches, they are looking for the ‘embedded advice’ which comes in the form of multi-manager products.”
One of the main reasons that the Hausbank relationship is weakening is the banking law two years ago that gave a green light to outsourcing. This led to the so-called break-up of the value chain. This in turn has forced asset managers to decide which asset management activity they want to focus on.
Nicolas Ebhardt, managing director at Union Investment in Frankfurt, sees a choice of three roles that are available to asset managers – administration, production and distribution: “We see a lot of specialisation taking place in the production role,” he says. “We see a lot of specialisation taking place in the production role. We came to realise that we needed more specialised ‘performance factories’
either within our own organisation or outside if we don’t have them and
if we don’t want to build them ourselves.”
As a result, Union Investment has created a number of partnerships. For example it has teamed up with Swiss company Partners Group to produce hedge fund of funds products.
Union PanAgora, the quantitative asset management joint venture between Union Investment and Boston-based PanAgora, is such a performance factory that Union
treats as a stand-alone operation. “Although it is part of the group, they have their own investment processes, their own culture and their own way of working,” Ebhardt says.
The collapse in the equity markets post 2000 forced the insurers reduce their equity exposure drastically. When the equity markets recovered in 2003 most of them missed out.
James Dilworth, head of the investment management division at Goldman Sachs in Frankfurt, says insurers were forced to act: “They realised that, with interest rates at historical lows and the promise made to policyholders still at above market levels, something had to change in the way they invested their money. Just betting on beta to deliver the returns required to offer their policyholders a 5% plus in an environment, when you had long-term government bonds yielding 3.5% to 4%, wasn’t going to work. So they started investing again this year.”
But invest in what? Insurance companies currently have an exposure to equities of between 10% and 15%, with the bulk of their assets in fixed income. To get the required 5% plus they had to consider alternative strategies such as global asset allocation and active currency management.
“Global tactical asset allocation overlay has worked very well for German insurance companies where for very little incremental risk you can add 2-3% overall return to your portfolio,” says Dilworth. “Investing in currencies as an asset class has also been very popular strategy this year.”
Yet German insurers and pension funds are highly constrained in how much risk they can take and this restricts the degree to which they can change their asset allocation.
Timothy Blackwell, head of Germany at UBS Global Asset Management in Frankfurt says: “The regulatory framework, the stress tests and the limitations set from a regulatory perspective has put the insurance industry under tremendous pressure. They are already cornered into a situation where they
can hardly move in terms of adding different components to their asset allocation. It’s very much a buy
and hold strategy on the fixed income side.
“That’s one structural issue that’s quite challenging for the insurance industry in Germany. In terms
of their risk budgets they are very
constrained. The same applies
to many pension funds which have
very low risk budgets.”
German institutional investors have traditionally been happier with total returns than with relative returns, and the current climate has encouraged some institutional investors to return to this approach. Gerhard Wiesheu, partner at Metzler Asset Management, says the three year bear equity market has created a demand for total return products. In response Metzler has teamed up with Frank Russell to provide a multi-manager long-only fund of funds. “This was a move to meet what we see as a strong demand for total return products from clients,” he says.
The move to specialist managers in Germany has mirrored developments elsewhere in Europe over the past two years. Yet the current climate may have halted this. Robert Hau, head of Continental Europe, Bank of Ireland Asset Management (BIAM), detects a shift back client demand from specialist to mainstream asset classes: “Last year we had big searches from companies like Degussa looking for asset managers abroad, mainly in specialised equity classes such as US small caps. But they have moved away from this. This year I see more activity directed to global and European equities.”
The choice of investments or institutional investors has been widened by the new investment law, which came into force at the beginning of the year. This lifts restriction on investing – notably in hedge finds. This is one of the ‘technical issues’ that has been absorbing the attention of asset managers this year. The main question is: will the law lead to a more adventurous asset allocation? Asset managers are not holding their breath.
Peter Schwicht, managing director of JP Morgan Fleming Asset Management (Europe) in Frankfurt, says: “As always this is a long term opportunity rather than an immediate one. Investors will put their toes in the water to see how it works for a year or two. If it works well then there will be more investments.
“But it’s not the case that German investors are getting more adventurous, and I think that's right, because these investors have fiduciary responsibilities and they need to get to know the subject. One of our biggest challenges is to educate clients on what hedge funds and find of hedge funds can do.
“You also have to look at the restrictions. Yes, institutional investors can invest directly or through fund of hedge funds but then the insurance companies or the pension funds have to show the regulator how they deal with it and that they have to have the right risk management systems and the right people in place. This is a challenge.”
Some four or five asset managers have entered the fund of hedge fund market as a result of the new law. One of these is UBS Global AM, the second largest hedge fund provider worldwide after the Man Group.
Blackwell at UBS Global AM says: “We are in the process of developing a fund of hedge funds solution within the framework of the new investment law and we will be launching this in the course of the fourth quarter.”
Funds of funds will be concentrated on five hedge fund strategies and proprietary funds due the tax transparency requirements, he says. “There will be very few funds in Germany initially that can fulfil this tax transparency, but as the industry grow and becomes established this could be opened up to non-proprietary products.”
Growth may be slow, he warns. “Pension funds are thinking about it increasingly but they are taking their time. But we definitely see that this trend is going to happen within a overall portfolio context.”
One brake on the growth of investment in hedge funds is the regulators’ heavy hand, says Dilworth at Goldman Sachs: “The law has certainly liberalised the regulation of hedge funds and allowed hedge funds to be sold to the retail investor. However the way they have done this is somewhat unfortunate.”
The problem is the requirement that hedge fund managers’ positions should be visible “The German regulators require complete transparency. If I’m a hedge fund manager and I basically get paid to find opportunities in the market place before everybody else does I’m not going to tell anybody about that once I’ve found it.”
Dilworth contrasts the situation with Ireland “The Irish central bank ‘s transparency requirements are not as onerous. They require the amount of leverage to be disclosed, they require NAVs and certain risk data to be provided but it stops there.
“I accept that investors want to know what they’re investing in. However. If I’m buying a fund of funds I should be able to find a good manager who has the risk tools to be able to peek into the black box and understand what’s going on. I don’t need to know what fund 27 did yesterday. For one, how am I going to be able to process that information? What does it really mean ? It’s asking for information that no-one can really use or process but making it nevertheless a requirement.
“This requirement has kept some of the best managers away from this market because they’re not going to open up their books.. and I think it has actually increased risk to the retail investor because they’re not getting access to the best.”
Another ‘technical issue’ exercising asset managers currently is the master KAG, the discretionary investment management vehicle introduced two years ago. Here there is little doubt that the effects have been positive. Schwicht, at JP Morgan Fleming AM, says it has made life easier for institutional investors. “This is now really standard procedure which has a lot of benefits for clients . Reporting in the same format and timeframe makes it much more convenient and transparent, so that clients can look at the reports and compare the different asset managers.”
The master KAG has also provided a way into the German market for foreign managers. Hau at BIAM says: “As a new player it’s a good time to be in the market. The changes in the KAG law introducing the master KAG give us more opportunities to get a share of the German market and the possibility of managing money for German pension schemes.”
The new vehicle also provides a way for asset managers that have their own KAGs to offer more ‘exotic’ asset classes. Schröder at Invesco says: “Although we do run our own KAG in Germany we have never accepted the costs of having exotic asset classes within the KAG. You need price feeds and systems that are uncommon in the German and European market. So we have not actively sold exotic products into Invesco KAG Spezialfonds.
“Now the master KAG has become more common and they need to be able to offer virtually everything. So it’s easier for us to go into a m aster KAG with exotic instruments without the cost of having to set this up.”
Invesco has no plans to set up a master KAG, says Schröder. “We took a strategic decision three years ago that we are not going to offer any master KAG services. We’re still pretty happy with that decision.” He is also happy with the decision to set up a single KAG in 1987. “A KAG was a pre-condition to survive until three or four years ago. To be a really respected member of the club we had to have a KAG. Paying the fee for membership of the club was worth doing even if we had to pay a high price.”
For some asset managers, the most immediate and beneficial effect of the new investment law is in the relaxation of the limits applied to pooled funds in segregated accounts. Previously institutional investors were limited to a maximum of 5% of pooled funds in a segregated account. This has been increased to 100%.
Jens Schmitt, managing director JP Morgan Fleming Asset Management (Europe), says: “We see pooled vehicles as the first big positive impact of the new investment law because it is offering a lot to clients.”
Schmitt says that pooled funds will enable smaller players to access a wider range of asset managers and investment strategies: “The smaller players in the market are taking this opportunity to diversify their portfolios. Pooled funds are coming increasingly within the focus of investors trying to play special themes like China.”
Pooled funds also make it possible for investors to allocate relatively small amounts to different asset classes, he says. “People are thinking about adding emerging market debt and high yield as asset classes to their portfolios even though its only E5-10m. In a direct investment they would be unable to diversify into that asset class with such amounts. Now they can use a pooled vehicle.”
The technical issue causing most interest among asset managers, however, is the potential impact of the International Financial reporting Standards (IFRS) on Spezialfonds, the vehicle specially designed for institutional investors.
Currently application of the IFRS, which is likely to be adopted by multinationals, will place a heavy reporting requirement on them if they own Spezialfonds. Claus Sendelbach, director at DekaBank IM explains: “Under IFRS rules if you are 100% the owner of a segregated account you must report for each single security separately. However, if you are only using a maximum of 20% of the fund you don’t have to report each single asset or each single stock. You are able to report that part of the of the fund as one security .
“That is the big advantage of using mutual funds because then you have only one data and not thousands of data details to report.”
The IFRS requirement could encourage a switch out of Spezialfonds, some asset managers fear. Ebhardt of Union Investment says: “We’re unhappy that Spezialfonds alone may at some point trigger the need to do IFRS reporting. We are worried that investors might move to less regulated vehicles which would be quite contrary to what the Spezialfonds does, which is protect the investor by regulating portfolio diversification and investment limits.”
Union Investment and other
asset managers have developed so-called institutional funds, which are really retail mutual funds for institutional investors, to get round this requirement.
Multinationals in Germany are also creating new business for asset managers in another way, by moving their pension assets and liabilities from their balance sheets into a Contractual Trust Agreement (CTA).
CTAs are attractive because they enable corporates get the best of both worlds. They can take their pension assets and - more important - liabilities off the balance sheets. At the same time they can benefit from the positive tax treatment of book reserving.
In other words, CTAs allows a multinational to both fund for international accounting purposes and reap the German tax benefits.
Ric Van Weelden, European partner at Watson Wyatt, says that multinationals have taken the lead in the move into CTAs: “ The CTA is a neat construction because they are ear-marking assets against liabilities which are still on the balance sheet. But they are funding them and one of the key things about CTAs is that it’s being funded outside the scope of normal trustee law. It’s a corporate finance business initiative, unlike, say, pensionskassen.
“Because of this the corporation is completely at liberty to allocate its assets as it sees fit. If it decides to allocate all the firm’s working assets to earmark it against its pensions liabilities then it can do so. They can apply prudent man principles to investment rather than be bound by investment limits. It is, in effect, introducing an Anglo-Saxon style approach to investing German pension assets.”
The asset management market in Germany is a highly fragmented, and particular developments cannot usually be applied generally. But perhaps where multinationals lead, others may follow, and the German asset management market will begin to take on more of the characteristics of its foreign competitors.

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