German Asset Management: In the face of headwinds
Never before has the German institutional asset management industry faced headwinds such as those currently confronting it, writes Clemens Schuerhoff
‘In light of the low interest rate environment….’ is how countless experts preface commentaries on the challenges facing asset managers. While low interest rates need to be discussed, as a subject matter it is stale, and far from the only problem.
The environment as a whole, and the challenges it presents, is unprecedented and influenced by many factors – but one has to differentiate between retail and institutional business, the latter being the topic for discussion here.
Perhaps the greatest challenges are the investment dilemmas of asset owners, including the structural allocation of the inflows from the insurance and occupational pensions sectors. These must generate consistent, high-quality return, covering long-term liabilities – both in terms of outperforming the legal minimum return rate and matching cashflows – with duration mapping of both sides of a liability-orientated institution’s balance sheet.
Liquidity is high, which is reflected in the levels of net Spezialfonds inflows, but so is the pressure to invest quickly – due to the ‘account charges’, effectively negative interest rates, charged by custodians. These range from 40-80bps and increase as more cash is left in the account.
As a result, inflows are invested as rapidly as regulatory restrictions permit. In the fixed income space, the entire universe is exploited – from Bunds, despite low or negative yields, to emerging market debt and corporate paper. Exposure to equities is increasing, while real assets – ranging from infrastructure to real estate and private equity – are highly sought after, including in listed form.
This means portfolio complexity is increasing and investors are edging up their exposure to risk, which poses challenges for portfolio-level risk management. Nowadays, it is impossible to apply portfolio insurance, hedging or overlay to the entire portfolio of a German institution, which adds problems, including the lack of liquidity. This can result in difficulties for asset managers trying to make larger trades. The European Central Bank and national central banks are exacerbating the problem by chasing the same assets as pension funds.
In addition to the low-return environment comes new regulatory initiatives – those impacting the asset management industry, and its clients. These require new solutions.
Among the initiatives that affect asset managers are the European Market Infrastructure Regulation (EMIR), the Alternative Investment Managers Directive (AIFMD) and UCITS V, where there is a constant need for improvement.
Probably the most topical regulatory initiative is MiFID II, as well as changes to the tax treatment of investments in Germany. While the latter tax reform impacts mutual funds more than Spezialfonds, it still requires attention to detail.
The European Securities and Markets Authority and the German regulator BaFin tirelessly issue ever more involved regulation, guidelines and consultations. Investors, meanwhile, are faced with the issues of Solvency II, IORP II, Basel III and BCBS 239, a further regulation drafted by the Basel committee, and many more.
The reform of Germany’s insurance laws, including new regulation governing investment behaviour, have by now been absorbed, but it is doubtful the new freedom to invest has been put to use across many of the affected portfolios.
Understanding the inter-connected nature of the regulations and how these translate into new investment products is one of the tasks facing asset managers. For example, Solvency II has seen the creation of own-capital-optimised investment approaches in compliance with new reporting requirements, supported by the regulation’s Tripartite Template (TPT). Developing such areas is a drain on resources, but can bring opportunities to boost income, attract new clients and improve relationships with old ones.
Implementing these regulations takes time and money and increases cost pressures, lowering margins, not all which can be recouped by charging institutional clients – especially as the German industry is already competitively priced compared with its European counterparts. As a result, asset managers will be on thin ice if assets under management and administration only increase gradually.
It is in such scenarios that the low interest rate environment applies greater pressure, as institutional investors need every basis point of possible return, including by driving a hard bargain on fees. Improving transparency on fees, while seeing a greater differentiation in products and prices, acts as a trade-off for asset managers, but an increasing reliance on passive investment and ETFs offers no relief.
Of course, Germany is also affected by the strategic themes impacting the global asset management industry, including responsible investment and associated portfolio implementation, blockchain, big data and robo-advice. These topics all impact asset management, and are championed by the German industry to a greater or lesser extent. But they underline the importance of continued investment in IT, personnel and business development to stay competitive in a dynamic market.
This article only offers an overview of matters affecting the German asset management industry. It could include a number of topics, or offer more depth on the ones addressed above. Many issues do not solely affect Germany, but rather are impacted by globalisation and European rule-making. In that sense, Germany is not the only market affected, but there are nevertheless unique aspects of the market worth considering. For example, the UK regards the Spezialfonds-market and the double oversight principle in the funds business with KVG and depot bank, as peculiar.
But, challenges can also see rewards for the industry. The market continues to show potential when it comes to retirement provision, and pension funds are the strongest-growing segment of clients within Spezialfonds. Combined with net inflows from insurance companies, consistently the largest of all investor groups, paints a rosy picture of the for the German investment industry, despite the headwinds.
Clemens Schuerhoff is chief executive of Kommalpha AG in Hannover