The historical backbone of the institutional asset management industry in Germany has been the universal bank offering asset management, brokerage and custody under one roof.
Over time, however, comparisons to the disintermediation trend in the Anglo-Saxon world of investment management, have gradually prompted the German market to discuss conflict of interest issues and examine how best to service clients.
And as clients themselves have begun to seek more specialised investment solutions, a shift towards the appointment of global custodians and reductions in the number of relationships with KAGs and the use of underlying Spezialfonds, has become apparent in Germany.
To this end, one of the most topical discussions in Germany, of late, has been to find the ideal structure for the investment and holding of pension assets.
As a result, a recent survey by German consultancy firm, Feri Institutional Advisors, looking at the investment arrangements of 205 German institutions came at a particularly pertinent time.
As Hartmut Leser of Feri explains, the consultancy identified German institutions by looking at four broad categories – insurance companies, pension fund type institutions – banks (savings banks) and industrial companies.
Having ranked the institutions within each category according to balance sheet size, Feri then set about identifying the most important financial strategy decision maker within each group, before arranging a personal interview.
Leser goes on to highlight the most important findings of the survey. “One general finding that we did make was that German institutional investors are definitely on the way toward Anglo-Saxon type behaviour.
“While German institutions may still be relatively heavily weighted in fixed-income, they are now under greater pressure for returns and having to look more at equities. Another important factor is that there is no longer the relationship type culture between institutions and banks that existed in Germany in the past.
“Institutions are now looking for the value added in their investments as far as possible. In Germany this is quite a new trend. While the relationship culture is still there, it really has started to diminish.”
Another new trend that Leser says Feri picked up was a gradual shift towards passive investment – an altogether new movement in Germany. “This is starting to happen slowly but surely, although it will take years for institutions to have the kind of passive weightings that are usual in Anglo-Saxon markets.”
An important factor in the passive move, he believes, is that investment education levels amongst German institutions have improved markedly: “Investors are now aware of the cost differentials between active and passive mandates. Not only that, they are also increasingly aware of where they should be placing such mandates. It is not necessarily a question today of going with their traditional active managers, but rather to a low cost provider of these services. The market has become quite well educated in this respect.”
Feri adds that the passive trend is also being driven by an increasing awareness about the use of benchmarks amongst German institutions.
“Ten years ago, nobody thought about benchmarks – then they were introduced and nobody cared about them, only after the fact, because when equities were rising it was very easy to beat the benchmark.
“We also found that five years ago there were quite a number of different benchmarks being used. That has now become concentrated to one or two types of benchmark.”
Consequently, he believes that so-called enhanced index mandates with 2–3% tracking error in equity portfolios trying to beat the benchmark could become popular over the coming years.
Mirroring the Anglo-Saxon markets, the passive rumblings in Germany, according to Feri, are also leading to the development of the core/satellite asset arrangement. “What we saw within the Spezialfond investments, which are essentially a very simple product, is a certain trend towards the core/satellite type of investment.
“For example, an institution might have two or three very large mandates with standard German banks with low tracking error and a couple of smaller mandates with less emphasis on tracking error.”
However, any noise in the market about alternative investments as the ‘satellite’ element of portfolios has yet to materialise, Leser notes. “In terms of alternative assets, we found that although there have been many publications, seminars and speeches on this in Germany where everyone was giving the impression that they were going to be investing a lot of money in alternatives, almost nobody did in the end!
“If you look at the weightings of alternative assets in the overall allocations of the 205 institutions that we talked, then on aggregate both types of alternative (hedge funds and private equity) will still be well below 1% by the end of 2003.”
Leser adds that a further question to institutions on their plans for alternative assets in the medium term, revealed a desire to increase allocations, but he points out that this will rise “from around zero to a little bit more than zero”.
“Nonetheless, this still means that there is a good market out there, albeit a niche market, with maybe a little more than E1bn in assets up for grabs.”
Leser explains that while alternatives – particularly hedge funds – may have caught the attention of institutions, private equity seems to have arrived a little late to rouse the interest of German institutions.
“People understand the basic ideas of hedge funds and they are looking at the full range, but from the legal point of view it is still difficult to invest in this asset class – you have to look at it in fixed-income type instruments. It is difficult to go for pure hedge products.
“Also, because of the equity markets at the moment there is concern regarding transparency and risk issues. Saying that though, I think hedge funds could be something for 2003–04.”
Leser goes on to highlight differences that the Feri survey identified between the ways that different institutional entities invest.
The survey divided the institutions into groups, with one denominator being an institution’s size in terms of assets.
“We found that the upper quartile of institutions – generally speaking insurance companies and the larger institutions – are a little bit further ahead in professionalism.
“I would think this is definitely a reflection of their size. Looking at the smaller institutions there is a definitely a marked difference, although medium sized institutions are also becoming more professional.
“Passive management, for example, is more widespread in the insurance sector, as are alternative assets.”
In terms of equity weightings though, Leser notes that it is pension funds that have the highest allocation – averaging around 20%, whereas banks, especially the savings banks, have something like 6% due to very tight risk controls on their investments.
Another angle that the Feri survey considered was the somewhat contentious issue in Germany of costs.
The traditional German costs structure for active management has been heavily influenced by the fact that most German asset managers are owned by a bank, meaning that in essence the broker owns the asset manager.
Leser comments: “In the past the German market has tended to reduce visible costs. Fixed investment fees have been relatively low and fees are generated through trading in the portfolios.
“We still have a comparatively high portfolio turnover compared with other countries, but today people are better informed about these costs and they are prepared to move away from the traditional German model.
“The shift now is to performance related fees and an insistence on best execution.”
Nonetheless, Leser points out that in 80% of the cases recorded by the survey, institutions note that their broker and custodian is the still from the same group as their manager.
However, the bundling tendency is beginning to unravel.
Says Leser: “Having a global custodian is a big theme in German asset management and has been for the last 10 years.
“However, if you ask custodians here, nothing has really changed.
“Only really in the last one and a half years have institutions started to unbundle asset management, trading and custody.”
According to Leser, many institutions revealed that they were now thinking about changing their bundled set-up.
“It’s the usual inertia, and I’m sure it will take years for this to change. It’s a slow move but there is a little bit more of it every year.”
A significant feature of the Feri analysis concerned views of institutions on individual asset managers. Feri whittled down a list of what it dubs the ‘Big 24’ of investment managers in the German market, where the group made some interesting findings.
“If you look at the top 24 players in Germany – including foreign managers – as mentioned in the survey, then you see that within the Big 24, 15 of the groups are German and nine are foreign, which is quite a lot.
“Five years ago out of the 24 top German managers you would have had 23 that were German organisations.”
More encouraging still for the foreign managers active in Germany will be the survey’s findings on market positions for these managers over the next few years.
“What we found is that for the foreign managers their potential is higher when we asked institutions to score their future prospects.
“The average aggregate potential for German players is –30, but for the foreign players it is +49.”
One reason for the increasing prevalence of foreign outfits may be last year’s amendment to the KAG law.
While institutions are almost obliged to manage institutional money through Spezialfonds for tax and regulation reasons, until last year it was obligatory for a manager to have its own KAG, a costly arrangement, before it could manage German institutional money.
Loopholes existed whereby foreign managers could acted as advisors to so-called ‘Rent-a-KAGs’, but this arrangement was frowned upon by the regulators. The law has now been amended so that the advisory role is legally recognised within the KAG set-up. Undoubtedly this has upped the profile of foreign managers to a degree.
A further knock-on effect of the new legislation, Leser says, is that institutions are talking about a number of future options within the KAG structure.
One is segmentation, or ‘multi-manager’ Spezialfonds. “This has just started and we expect much more of multi-manager Spezialfonds. It is a fast growing area, albeit from a very small base.”
Another clear trend elicited by the survey is that German institutions are today asking for more capabilities within their portfolio managers. To gauge what these factors are, Feri listed nine firm attributes and asked their institutional universe to score them in order of importance.
The attributes were: rational design of asset management structure and business, investment decision making process, buy-side research capabilities, equity and bond selection, timing, portfolio management personnel, organisational infrastructure, track record and implementation capabilities.
Leser notes that in terms of scoring there was actually very little difference between the points ascribed to each attribute.
“The most important, however, is systematic investment process and the lowest consideration is track record. People have learnt that you cannot just give money to managers on performance issues.”