In Germany, institutional investors are increasingly turning away from Spezialfonds in favour of mutual funds. Experts say this is largely because of the onerous reporting requirements they have to adhere to when invested in Spezialfonds, but there are other factors at play too.
“Three or four years ago, there were very few institutional investors that considered investing in mutual funds,” says Hartmut Leser, managing partner at Feri Institutional. “Whereas today, more and more institutions are considering this route.”
The real trend has only been noticeable this year and last year, says Ingo Biermann, head of sales and relationship management at BNP Paribas in Frankfurt. There are several reasons why an increasing number of institutions now intend to buy public funds rather than Spezialfonds, he says.
“The main reason for this is the new German reporting requirements under IFRS,” he says. What happened prior to the new requirements is that German corporations or insurance companies invested in a Spezialfond only had to report one position in their balance sheet. But with the international accounting standards, they have to report each individual security, he says.
“This is a cumbersome procedure for them,” he says. “Therefore as an alternative solution, if they buy a public fund, this requirement is not valid, and they can continue to report only one line.”
Another reason behind this is the general shift in opinion about the best way for institutions to achieve good investment performance. Several years ago, says Leser, it was accepted wisdom that institutions needed Spezialfonds - which are really segregated accounts - because they offered a tailor-made solution given their very particular needs.
“This opinion is disappearing, because people are realising that it’s difficult to find any good manager who can outperform,” he says. “If you find one, then you should let him do what he wants to do, because he is a very scarce resource.”
Tailor-made solutions have to be on a strategic level, he says. As soon as investors start thinking in this way, they might just as well look for building blocks to create their strategy – and these building blocks are retail funds.
Claus Sendelbach, head of institutional sales at Deka Bank, also puts the swing towards retail funds down to fact that institutions are keener than before to diversify.
“International diversification and style diversification is another way to reduce portfolio risk,” he says, and this means institutions are finding they need to have small proportions of their assets in certain niches, for example, 0.5% in Indian equities, to get good diversification.
When taking this approach, it is much more effective to buy into well-diversified mutual funds rather than getting a specialist manager to invest in just 10 or 20 assets in the niche the investor wants exposure to, he says.
Particularly for medium to smaller institutional investors, where there is this core-satellite investment approach, the satellite investments can be too small for Spezialfonds to be at all cost effective. Biermann says institutional funds have basic costs – a fixed cost block. For amounts of E30m or below, this fixed cost block would be too high.
As well as this, big investors are looking for more flexibility in choosing asset managers. “We realise that institutions want to be very flexible to hire and fire asset managers. Whenever you don’t like the quality, you can get rid of it within 24 hours, and get the same service from another asset manager,” says Sendelbach.
While in theory, it is possible to sell a Spezialfond within the same time frame, in practice it is not quite so simple, he says. “Because you are a single client of the manager, and the relationship is much more intense.” On a personal level, individuals at the institution may feel reluctant to sever the relationship even though on a numbers level it makes sense.
In this way, says Sendelbach, a Spezialfond arrangement is more like a marriage between asset manager and investor, whereas a mutual fund is like a date.
Frankfurt-based advisers, Funds at Work, note that in interviews conducted on behalf of clients, most investors commented on how flexible publicly registered funds are. “Units of publicly registered funds are easy to create or to redeem…Daily pricing at least for the open-ended vehicles is common,” it says in a briefing.
Leser makes the point that retail funds and Spezialfonds are not as far away from each other as they used to be several years ago. While it used to be the case that institutions buying into retail funds had to pay retail costs, it is now possible to buy the same funds but at a cost which is much more acceptable to institutions.
Many asset managers have realised that institutions are more than ever prepared to buy these retail funds, so they tend to offer different terms for the institutional market. This is the case with iShares, for example, he says.
But where asset managers do not automatically offer institutions reduced fees when they buy into retail-orientated funds, large investors can and do negotiate successfully. “Institutions negotiate with the fund manager for institutional fees,” says Biermann. They agree that they are not charged subscription fees and also that they participate in the trailer fees, he says.
Funds at Work says mutual funds are significantly more expensive than mandates at first glance. Using European blue-chip equities as an example, the average management fee for mandates, according to recent studies by Greenwich and Dr Heissman, is about 33 basis points. A comparable mutual fund is not usually available for under 60-70 basis points.
“If the costs cannot be cut down with institutional share classes, there is still a possibility for retrocession fees,” says Funds at Work. “The ideal format would be a retrocession fee which could be compensated against a variable outperformance fee.”
But even so, multi-owner vehicles would still be more expensive than mandates, it says. This is the price that has to be paid for features like enhanced flexibility to exit at any time. “This intrinsic value is usually not considered in these calculations,” it says.
Funds at Work differentiates between multi-owner vehicles and publicly registered funds – the former can also be funds that are not registered in the domicile of the local institution.
Leser sees the trend continuing. “We think it will go further,” he says. “In Germany currently, and particularly in the past, Spezialfonds and public funds have been seen as completely different worlds. We think this gap will shrink further and further.”
This huge shift can be seen in the changing structures of asset management organisations. Deutsche Bank, for example, used to have two different departments for mutual funds and funds geared towards the institutional market. Everyone was convinced that these were two different skills, says Leser, but now Deutsche has merged the two operations.
“Everything is shifting towards this ‘one-world’ approach,” he says.
Biermann also sees the trend continuing. “In the most recent RFPs, we have seen questions (about public funds) which we have never seen before,” he says. Institutions are asking about the manager’s expertise in the realm of public funds, he says. Also evident from the new questions, is the fact that institutions still have a lack of experience and information about mutual funds, even though the intention to use them is clear.
Funds at Work has no doubt that Spezialfonds will continue to exist and provide certain large investors with advantages. “But the increasingly modular investment industry has the opportunity now to create many new relationships and solutions, focused on customer needs as part of a holistic strategy,” it says.