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Signs of recovery (part one)

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When someone ‘borrowed’ Tom Wolfe’s novel ‘The bonfire of the vanities’ and turned it into a bestseller all over again, this time called ‘The campus’, but without mentioning its source, the press headlines read: “Raider’s now called Twix”. This article could very well have the same heading, because from next year, the type of investment fund that is set up exclusively for special investors is no longer to be called the ‘Spezialfonds’ but ‘Spezial-Sondervermögen’. This sort of rebranding is something which has carried this name since 1990, certainly doesn’t need, although there are signs of a certain consolidation.
In 2002 there was a further decline in Spezialfonds volume, after this report last year noted the first-ever downturn in Spezialfonds volume. And this new decline of 5.5% has turned out to be much stronger than the relatively minor 1.4% downturn in 2001. Last year’s forecast, which suggested that this downturn was not the start of a negative phase for this investment segment, was therefore not by any means wrong, since the decline in volumes in 2002 was also solely attributable to the renewed negative trends on the capital markets. And as the capital markets have recovered, the negative trend has also been reversed. As shown in Figure 1, the total Spezialfonds volume resumed its growth in the first five months of this year.
There is therefore some reason to hope that the period of decline is already over and that the Spezialfonds will be able to resume the positive trend it began with.
This beginning was not in 1957, as when the German law on investment companies, the KAGG, first came into effect, it made no provision for the investment fund specially created for institutional investors, the Spezialfonds. The lawmakers had started with the idea of the small investor, who would gain access to the capital markets via the investment fund. Nevertheless, several institutional investors soon realised the advantages of investing in investment funds compared to direct investment, and had funds set up by investment fund management companies (Kapitalanlagegesellschaften, KAGs) especially for their own investments. However, the German federal banking supervisory office
(Bundesaufsichtsamt für das Kreditwesen, BAKred) only approved such funds if it was ‘social capital’ that was being invested, ie, if the investors were institutions who were managing their assets in the interests of the ultimate beneficiaries, small investors such as insurance policyholders. When the German Bundesbank included such funds in its capital market statistics for the first time in 1968, when they were still referred to as ‘Individualfonds’, there were 13 funds with a total volume of DM147m. So compared to the 31 retail funds, or Publikumsfonds, whose total volume was DM6.3bn, they were of very little significance. This changed over the next two decades, and in 1989 the Spezialfonds had caught up with the Publikumsfonds in volume terms (see Figure 2).
When the 1985 UCITS Directive was incorporated into German law in 1990 with the (1st) financial market promotion act (Finanzmarktförderungsgesetz), the lawmakers used this opportunity to formulate a statutory definition of the Spezialfonds. The basis for this was the strong growth of this instrument and the fact that the BAKred, as the supervisory authority, had by the end of 1989 already had to approve the contract terms of 1,474 Spezialfonds. The formulation of a statutory definition now opened the way for the supervisory authority to pass responsibility for approving the conditions of Spezialfonds on to auditors. In addition, there was provision for further relaxation, such as the abandonment of the daily publication of unit values. Now that the law had recognised the Spezialfonds as an investment medium, it began to grow every more strongly. The flow of revenue into the Spezialfonds overtook that of the Publikumsfonds, as can be seen in Figure 1. In 1998, revenue reached a temporary peak of E66.9bn. In 1999 revenue had already started to fall back, but the 28% increase in volume remained almost as high as in 1998 (31%), probably due to the favourable conditions on the capital markets. Then in 2000 the growth rate in fund volume was down for the first time for many years, just below 8%, and the previous peak level of Spezialfonds volume was reached, at E514bn. This was followed in 2001 for the first time ever by a slightly negative trend in fund volume and after the renewed decline over the past year fund volume totalled only E482bn. By the end of May the volume had climbed back to over E504bn (albeit including the specialised real estate investment fund, the Immobilien-Spezialfonds, which was now attracting some attention, with E12.3bn).

Negative influence of capital markets on volumes
Even after the 5.5% decline already referred to, the total volume of Spezialfonds as at the end of 2002 was still E470bn (excluding Immobilien-Spezialfonds). If we compare this fall in total volume with the inflow of revenue and dividends, this produces a market-related loss in value of E44bn, or 8.9% of the starting volume (see calculation). For the previous year, the losses related to the capital market had been much lower, at E31bn.
If we now apply the market-related loss in value thus calculated to the assets managed by the Spezialfonds, which at the beginning of 2002 had totalled E186bn, this produces a loss of 17% of the asset portfolio available at the beginning of the year. Compared to the value trend on the DAX (- 44%) or the EuroSTOXX 50 (-37%), the losses by Spezialfonds were therefore less than those on the conventional comparative indices, and, of course, part of the losses in share prices has been offset by gains on the bond side, but on the other hand it is also true that part of the overall loss has been caused by the decline of the US$. In this respect, however, it is still interesting to note that the asset portfolio in Spezialfonds at the end of the year amounted to E120bn. But this figure could not be arrived at simply from the calculated E44bn value losses. It is much more likely that the fund managers have actively reduced their equity quotas by disposing of equities.
In overall terms, 25.6% of Spezialfonds’ assets the at the end of 2002 were still invested in the equity market. By the end of May 2003, with the equity market beginning to recover, this quota fell by a further four percentage points to 21.7%, which means that share quotas have been further reduced. Up to March the falls were attributable to market falls mainly, after that it was active selling. Accordingly, the share quota is continuing to move away from the long-standing figure of just below 30% that was evident in the 1980s and up to the mid-1990s, see Figure 3 ‘Composition of Spezialfonds’. It would, of course, have been more advantageous now, with equity prices particularly low, to work back up to the original quota and to desist from further selling. But it would probably be wrong to accuse fund managers of cyclical behaviour. It is more likely that many institutional investors are simply unable to permit a higher quota of equities in their Spezialfonds because of their unwillingness to carry the risk. However attractive it may seem (and did seem earlier in the year) to move back into equities because of low prices, if an investor is unable to afford any further losses, the risk of further losses has to be excluded at the cost of the best price opportunities. Against this background, the days of 1999 and 2000, when a good 45% of Spezialfonds volume was invested in the equity market, are unlikely to return in the longer term.
In this connection, it is worth noting that the proportion of domestic equities fell from 5.3% at the end of 2002 to below 5% at the end of May, the lowest point since records began. Nevertheless, the absolute value of domestic equities, at approximately E25bn, has remained more or less stable, while the value of foreign equities over the same five months has been reduced from E95bn to E82bn. By contrast, the proportion of bank deposits is fluctuating at its highest level since 1992, at over 8%.
There are also signs of a possible trend reversal in the proportion of foreign securities in the Spezialfonds. From a temporary high point of 51.3%, reached in 2001, during 2002 the foreign share sank to 50.6%, with the proportion of foreign equities falling from 28.8% to 20.3% and the proportion of foreign bonds increasing from 22.6% to 30.3%. These trends continued in the first few months of the current year, with foreign bonds increasing by a further 3.6 percentage points and foreign equities losing 3.5 percentage points. It would seem that many institutional investors wish to reduce the equity risk further and at the same time look for earnings opportunities such as those that may be offered by international corporate bonds or asset backed securities.

Decline in number of funds, despite substantial inflow of revenue
The inflow of revenue into the Spezialfonds in 2002 was once again lower than both of the previous years, at E33.6bn (2000: E45.4bn, 2001: E41.3bn). Nevertheless, revenue of this order cannot be disregarded, and a parallel increase in the number of funds might have been expected. In the two previous years, for instance, the number of Spezialfonds rose by 584 and 499 respectively. Had this trend continued, by the end of 2002 the number of Spezialfonds would have been just below, or maybe even over 6,000. But remarkably, the number of Spezialfonds actually fell in 2002, despite the inflow of revenue, by 178 to 5,372 Spezialfonds. There are a number of explanations for this phenomenon:
o Investors with several Spezialfonds are pooling these under the control of a ‘master-KAG’;
o Insurers are pooling their Spezialfonds, because under the new investment directive (Anlageverordnung) there is no longer any necessity to split them into straight bond-based funds (Reine Rentenfonds) and equity-based funds (Aktienfonds). Whereas previously a mixed mandate was weighted completely at a risk capital ratio of 30%, in the case of transparent investment funds it is only the actually available equity holdings that need to be weighted at a risk capital ratio now increased to 35%;
o With rising pressure on costs, the KAGs are increasingly taking the economically viable size of individual Spezialfonds mandates into account.
o It is possible that the inflow of revenue observed stems mostly from existing investors, so that the volume of existing funds is increasing, but new funds are not being set up to the same extent as in previous years. If the unit values of Spezialfonds are below the acquisition costs reported in investors’ balance sheets, any increase will lead to a reduction in average acquisition costs. In many cases, this can make it easier to argue that the remaining difference is relatively small and represents merely a temporary loss in value that does not have to be written off.
It seems most unlikely that any one of the above reasons is solely responsible for the trend as described. It is more likely that each of the explanations has played a part. In the current year, in any event, it is expected to continue, as in the first four months the number of Spezialfonds has fallen by another 18, although in the same period they have already had an inflow of new revenue totalling E13bn.

No changes for Kandlbinder studies
The survey established by Kandlbinder and conducted over many years has been carried out again this year with no changes. For the survey, each individual KAG is asked about the managed Spezialfonds volume as at the year end, the number of Spezialfonds and the structure of the investors which were investing in these Spezialfonds on the survey date. Although the Bundesbank also publishes the structure of Spezialfonds holders in its capital market statistics, the present survey enables not only the application of a somewhat variable system, but also a more far-reaching evaluation to be carried out, in which the structure of Spezialfonds holders relative to the different groups of providers can be analysed.
This would not be possible using the Bundesbank statistics. The findings of the Bundesbank statistics on the one hand, and those of the survey carried out by the author on the other differ in many respects. The obvious differences may be explained, firstly, by different classifications, ie, a different definition of investor groups on the one hand and a different methodology for classifying multi-investor funds (Gemeinschaftsfonds) on the other. The Bundesbank allows the reporting KAGs on form 10 380 in column 08 ‘type of unit holder’ only a non-selective response, including for mutual funds (Gemeinschaftsfonds). So, even if several investors from different investor groups are participating in a Spezialfonds, the whole of the fund’s assets will be allocated to the largest investor group. As a result, the volume of the largest investor group may be overstated and the volume of the other investor groups in a mutual fund understated.
Using the methodology of the Kandlbinder study, however, we attempt to find out the exact amount of the interest of the different investor groups in a KAG, irrespective of whether the investors concerned are investing in an individual fund (a Spezialfonds with just one investor) or as predominant or minority investors in a mutual fund (Spezialfonds with several investors). That is because ultimately the aim of this study is to determine the exact sales volume of Spezialfonds units among the different investor groups, whereas the Bundesbank is more interested in structural questions about the market at the level of the instruments, that is the Sondervermögen.

Survey participation
Once again for the 2002 survey, it was pleasing to note that all 59 KAGs took part, and according to the Bundesbank statistics on the survey date they were managing a total volume of E470bn in 5,372 Spezialfonds. So once again it was possible to include the entire Spezialfonds market in the investigation. In evaluating the survey findings, however, the total volume is a good E7bn higher than that recorded by the Bundesbank, and the number of Spezialfonds is higher by 19 funds. The clear variation in total volume compared to previous years is based at least in part on subsequent corrections by individual
companies. The variation in the number of funds may have been caused by calculation errors. It may well be impossible completely to avoid such variations, but fortunately they are also relatively small, and do not detract from the meaningfulness of the investigation.

Changes in providers
In the Wertpapier- (securities-based) Spezialfonds sector, there have been few new Spezialfonds-KAGs established. Unlike the Immobilien-Spezialfonds, where currently each year two to three new KAGs are established; in 2002 there was only one new one, BHF-Invest, just as there had been in 2001. But in 2000 the number of Wertpapier-Spezialfonds providers increased by eight KAGs. Since then, the total number of competitor providers has stayed the same, at 59 companies, and in 2002 there were three additions, three departures and two re-groupings.
One new arrival is DWS, which since the takeover of Franken Invest and Zürich Invest also manages Spezialfonds. SwissRe is another existing company which had previously only offered retail funds (Publikumsfonds) that is now also setting up Spezialfonds again. In 2000 this company, as CDC, had been classified with the foreign bank subsidiaries group with its Spezialfonds, and in 2001 following the change of name to SwissRe had no Spezialfonds under its management. The only genuine newly-established company is BHF-Invest, which is looking to focus its operations in the area of master-KAG services.
Against the three new providers, there were three liquidated or merged KAGs. Apart from the two KAGs taken over by DWS, particular mention should be made of Allianz-KAG that has been transferred to dbi, because of the resulting effects on the statistics. Just as in the case of Zürich Invest, the total volume of Spezialfonds of Allianz-KAG is now no longer included with the group of insurance KAGs but with the group of KAGs of major and regional banks, as a regrouping of dbi with the insurance KAGs was ruled out. These two takeovers are responsible for the fall in the market share of the insurance KAGs by 6.2% down to 14.2% and the reciprocal increase in the market share of the KAGs of the major and regional banks, also by 6.2% up to 34.8%. While the KAGs of the major and regional banks still indisputably have the lion’s share of the market, the group of insurance KAGs fell from the number two spot that it had barely reached in 2001 back to third place. In second place once again are the KAGs of the savings banks (Sparkassen) and central savings banks (Landesbanken) with an unchanged market share of 20.2%.
Over and above this, there were only minor shifts between the provider groups, and these too can at least in part be explained by company regroupings. The KAGs of the foreign banks lost 0.9 percentage points, which can only partly be explained by the classification of Union Panagora (formerly: DG Panagora) with the cooperative sector. The KAGs of the cooperative banks (Genossenschaftsbanken) even extended their market share by 1.2 percentage points, which puts them alongside the’other KAGs’ with an increase of 0.5 percentage points, among the winners in the fight for market share. Finally, Nordcon was reclassified from the group of insurance KAGs to the Sparkassen und Landesbanken group. The former Saloman Brothers KAG has now had its name changed from First Private KAG to Investment Partners KAG, although this did not involve any regrouping.
The takeovers referred have also had relatively significant effects on the structure of Spezialfonds holders in the different KAG groups. The KAGs of the major and regional banks, for instance, increased the proportion of insurers among their Spezialfonds investors from 24.2% to 36.1%, which is of course primarily due to the mergers of Allianz-KAG and Zürich Invest with dbi and DWS respectively. The proportions of all other investor groups have been reduced correspondingly, although it was not possible to draw any further conclusions from this inevitable reduction, as ultimately the total of all investor groups is still 100%.
In the investor structure of the insurance company KAGs too, the mergers of the two companies has affected the bank KAGs, but these are comparatively marginal. The proportion of insurer-investors in the insurer KAG group fell by a mere 2.2 percentage points to 86.6%. A bigger change is evident in this KAG group in the case of own (Depot-A) funds, where the credit institution invests its own funds, this proportion more than doubled from 1.7% to 4.0%.
In the savings banks’ and central savings banks’ KAGs the Depot-A funds are not now quite so predominant, with 60.0% of the investors, as are the insurance investors in the insurance KAGs, but here too they form the mainstay of the business. In 2002, this proportion actually rose slightly; the previous year it had been just 58.2%.
No analysis was carried out this year on the market share of the KAGs of the cooperative banks and the ‘other’ KAGs, as these groups comprise only a few KAGs and some of them are dominated by very few providers. Publishing the corresponding figures could therefore have enabled conclusions to be drawn about the customer structure of individual companies, and this is precisely what the survey does not set out to achieve.

Average fund volume relatively constant
The declining number of Spezialfonds and the capital market related fall in total volume results in a corresponding change in the average volume of the Spezialfonds. In 1999, this average volume reached its all-time peak of E99m. It then sank to E91m in 2001 and to E90m in 2002. The first five months of this year saw it rise once again, to E95m.
By comparison, the development of the average fund volume in the Publikumsfonds is much more volatile. From its 1999 peak value of E260m, the average Publikumsfonds fell to a volume of E158m, representing a decline of almost 40%. Here too, there are already signs of a slight recovery, as at the end of May 2003 the average Publikumsfonds volume had already climbed back to E162m.
The differences among the individual KAG groups are interesting. The largest average fund volume is traditionally managed by the group of ‘other’ KAGs, and at E330m the Spezialfonds has remained practically constant. Among the insurance KAGs, however, there was a perceptible decline of about 20% to the present E195m. There were further falls recorded among the major and regional banks, from E81m to E70m, the KAGs of the foreign banks from E70m to E65m, and to a fairly small extent the savings banks and central savings banks KAGs, from E68m to E66m per Spezialfonds. The only groups that saw increases were the private bank KAGs, from E59m to E88m, and the cooperative KAGs, which managed to lift the average fund volume from E60m to E70m. Just two years ago, this group held on average the smallest Spezialfonds, and that is possibly why the targeted efforts to increase the size of the funds are now starting to bear fruit. The same is true of the private banks’ KAGs, which in 2001 experienced a sharp fall from E73m to E59m per Spezialfonds and on this basis could well achieve an even stronger rise in average volume.
Analysis of Spezialfonds investors
According to the Bundesbank statistics, the insurance companies’ share of total Spezialfonds volume has been falling slowly since 1999, see Figure 5. While in 1999 insurers still owned 50.5% of all Spezialfonds units, by the end of 2002 this had fallen to just 48.2%. In the first five months of this year, this figure fell by a further 0.8%. This does not, however, indicate that interest in Spezialfonds is waning among insurance companies, because the insurers’ share of revenue into Spezialfonds, which is calculated by the Bundesbank using the same methodology, has grown continuously over the same period, and last year amounted to 75% of the total Spezialfonds revenue. This figure is, however, exaggerated and comes about mainly because in the ‘Other Enterprises’ sector in November and December in net terms over E5.7bn went back to the investors. But if these return flows are discounted from the statistics, the insurers still have a share of over 60% of the total revenue in 2002, compared to 60% in 2001 and 67% in 2000. In each case, the insurers’ share of revenue over this period has been higher than their share of fund volume.
But if the insurers’ share of volume is falling, even though their percentage share of revenue is greater, the reason can only be capital market related changes in value. It must therefore be concluded from these figures that compared to the Spezialfonds of other investor groups, the Spezialfonds held by insurance companies have recorded the higher equity quotas and accordingly also higher equity market related losses.
Also, the author’s own survey shows that the share of insurance companies among Spezialfonds investors has again fallen, and is now just 37.0% (2001: 37.8%). The share of investors from the institutionalised pension funds group, that is, the pension and support funds and retirement funds, have reduced their share of Spezialfonds volume by 0.7% to 14.4%.

Foreign investors are not taking advantage
In 2002, foreign investors had a volume share of E3.3bn, or 0.7% of the total, compared to 0.6% in 2000 and just 0.4% in 2001. In the Bundesbank statistics too, foreign investors are the smallest group with an unchanged 0.4% share.
It is interesting to make a comparison with the Immobilien-Spezialfonds, where foreign investors hold E0.9bn in volume terms, or just under 8% of the total volume. According to the Bundesbank statistics, the figure is as high as E16bn, or 13% (cf. ‘Der Immobilien-Spezialfonds boomt weiter’, in Immobilien & Finanzierung / Der Langfristige Kredit, 2003.
So, while the share of Immobilen-Spezialfonds held by foreign investors is certainly worthy of mention, the same group of investors is still virtually insignificant for the Wertpapier-Spezialfonds. That may be because of the basic way of looking at this instrument. Although in Germany the investment fund unit is regarded as a security sui generis, this view is not always shared by foreign investors, accountants, auditors, supervisory and tax authorities, who always focus on the assets available within the funds unless there are expressly special regulations for fund units. This is certainly not a correct view, as a fund, including the Spezialfonds, is actually not a managed securities portfolio, but a special investment instrument with its own special characteristics. But focussing on what is in the funds naturally leads to the Spezialfonds offering no advantages and being regarded simply as an unnecessary impediment to the choice of investment policy. So the area still has a lot of work to do to convince foreign investors of the advantages of this instrument.

IAS as an opportunity for the KAGs
It was expected that with the introduction of international accountancy standards (IAS) the Spezialfonds could lose the reason for its existence. There are now signs that precisely the opposite could happen, provided that the KAGs are able quickly and reliably to supply the evaluations required under IAS for the balance sheet presentation of securities. This is because the application of the relevant regulations for recording securities is no trivial matter, and could present some accounts departments with additional wide-ranging and unfamiliar tasks, and that at a time when the arrival of IAS is in any case necessitating extensive implementation and introduction projects. In such a situation, the Spezialfonds offers an ideal possibility for outsourcing one issue completely, namely that of recording investment portfolios. It would be no surprise if such an opportunity were not seized on by several new investors, all the more so because there is the prospect of a tax benefit by shifting the assessment date by one calendar year. This is because by applying IAS, no more earnings can and need to be distributed for the presentation of the income statement, so that taxation of earnings can be deferred by one calendar year by deferring distribution until the last possible date – depending on the financial year of the fund.

Significance of Spezialfonds for banks and insurers
Although, as we have seen, the volume of Spezialfonds investors from the insurance sector has fallen, insurers are still significant as they remain the most important investor group. This is unlikely to change in the near future, as can be seen from the insurers’ large share of Spezialfonds revenue already referred to, see Figure 10 (inflow to insurance companies Spezialfonds compared to all Spezialfonds investors). This shows that the flow of revenue from insurers remained virtually constant in 1999 and 2000 at over E30bn in each year, while total revenue was already falling sharply from its 1998 peak. Although in 2001 and 2002 there was less new money coming from the insurers (about E25bn in each case) their share of total revenue continued to grow, and in 2001 amounted to 60% and in 2002 as much as 75%.
In view of these substantial investments by insurers in investment trust units, the obvious question is whether this behaviour will continue for long, or whether there are possibly signs of saturation point being reached. Accordingly, in Figure 9 the value of investment trust units in the hands of insurers has been fixed in ratio to their total securities portfolio and to the total value of all capital investments. This shows clearly that the insurance companies have substantially increased the weighting of investment in unit trusts since 1975, both in their securities portfolio and in their total capital investments. The proportion of fund units in the total value of capital investments now amounts to a sizeable 22.8%, and the proportion in the securities portfolio now constitutes over two-thirds (to be precise, 67.7%). This means that the insurance industry relies on the Spezialfonds instrument in the securities segment and that direct investment, with barely one-third, now has an almost secondary importance.
Over time, the credit institutions have also invested an increasingly large proportion of their securities portfolio in investment fund units, even though the level is much lower compared to the insurers. The proportion of investment fund units in the credit institutions’ total securities portfolio rose from 0.7% in 1985 to the highest level to date of over 12% at the end of 2001. Since then the proportion has fallen back slightly, standing at 11.2% at the end of 2002 and at the end of May 2003 at exactly 11%. Although these figures from the Bundesbank’s capital market statistics also include Publikumsfonds units and other securities, from which only the MFIs could be disregarded. This does not, however, make them any less meaningful. If, for instance, we compare the total value of investment trust units reported by the Bundesbank in the credit institutions’ own holdings, just under E130bn, with the value of Spezialfonds in the credit institutions’ Depot-A according to the author’s own survey, this gives a difference of E1.16bn. This is the maximum amount that the credit institutions could have invested in units of Publikumsfonds, whereby a larger share also has to be allocated to those Publikumsfonds that are set up especially for the credit institutions’ own investments, which means that they are actually Spezialfonds for more than 10 investors.
Just as with the insurers, the slight fall of Spezialfonds units in the securities portfolio of the credit institutions in no way points to a declining interest or even a move away from the Spezialfonds instrument by this group of investors. It could quite simply be that many Spezialfonds have been more heavily weighted in equities than in direct holdings in the credit institutions’ Depot-A. That may not necessarily be so in each individual case, but there are some credit institutions that hold equities exclusively in Spezialfonds, that is, that hold exclusively bonds in their direct holdings. Sometimes, too, pure equity mandates are given to the KAGs, leaving bond management completely in direct investment. Such a division of functions does, however, to some extent lose the Spezialfonds their advantage, the compensating effect between increases in value and losses in value by different assets. Although this compensating effect is still present at the level of individual stocks held in the fund, but not at the level of the equities and bonds asset classes. In individual cases, there may be a write-down requirement that could have been avoided by transferring bond management to the Spezialfonds.

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