DekaBank, the central asset manager of the German Sparkassen Organisation, is Germany’s number one provider of structured investment concepts and fund-based asset management in the retail market. Due to the new possibilities of the Investment Modernisation Act, institutional investors can now profit from our know-how based on breadth of experience and capacity through institutional fund of funds vehicles.
Spezialfonds and public funds - a polarised landscape
Until the beginning of this decade, the structure of the German fund market was clearly divided in two: the mutual fund for private investors and the Spezialfonds for German institutional investors. The mutual fund is distinguished by the high level of standardisation in its construction and administration.
The Spezialfonds prevails as the first choice of investment for institutional investors such as financial institutions, insurance companies and pension funds. The Spezialfonds investor typically has certain influence over the accounting of gains and losses and dividend pay out (under German Commercial Code reporting), access to detailed and transparent reporting from the capital investment company (KAG), as well as an individualised investment policy.
The uniqueness of each fund led to the development of a strong relationship between the individual fund manager and the investor. The framework of the vehicle also led to the proliferation of the all-encompassing balanced fund (70% of all Spezialfonds) with a focus on active asset allocation.
Low volume Spezialfonds (and thus small equity and bond positions in the fund) led to less than optimal risk diversification. First attempts to solve this problem by having Spezialfonds purchase mutual funds were hampered by legal restrictions. Under the investment acts for capital investment companies (valid until 31 December 2003), the Spezialfonds could hold only a small percentage of assets in mutual funds. Additionally, the mutual fund had to meet certain criteria to qualify for purchase by a Spezialfonds - owned by insurance companies for example- which made very few funds available for purchase.
Mutual funds now attractive for institutional investors
What has caused the increased attractiveness of mutual funds for institutional investors such as pension funds and insurance companies?
The Investment Modernisation Act (1 January 2004) and the modification of §54 a of the Insurance Investment Law (VAG) into a revised ‘Investment Act for Insurance Companies’ allow the purchase of mutual funds within the Spezialfonds. The Spezialfonds may now be totally invested in mutual funds, restrictions on individual funds have been dropped and restrictions on non-domestic funds have been eased.
The migration of many investors from German Commercial Code accounting to IAS/IFRS confronts investors with new reporting hurdles. According to IFRS, institutional investors must report all individual securities held and all transactions. As a mutual fund is considered to be an individual security reporting complexity is drastically reduced.
Investors are willing to adopt new investment approaches to optimise risk-adjusted returns and domestic investment companies have positioned themselves to meet this demand. As a reaction to less favourable market conditions, domestic asset managers streamlined their product offering and pricing, improved investment processes, and refocused on core competencies. DekaBank subsidiary Deka Investment has gone through this process and offers investment building blocks with clear investment strategies and risk return profiles in the form of various vehicles. Simultaneously, to achieve higher risk-adjusted returns, institutional investors are more willing to move away from the limitations of benchmark oriented investing toward the ‘building block’ structure – or better known in Germany as the ‘cafeteria system’. The institutional fund of funds is an ideal vehicle for this purpose.
The advantages of institutional fund of funds lies in the more diversified investment strategy. Tactical asset allocation becomes more flexible as investors can easily manoeuvre assets between liquid mutual funds. Additional diversification can be achieved across various managers, and smaller satellite investments are simple to add.
The ‘Spezial funds of funds’ vehicle
To implement a mutual fund strategy for institutional investors, Deka recommends the implementation of a what can be called a Spezial fund of funds, with an experienced fund of funds manager as opposed to direct single investment in the mutual fund on the basis of an asset management contract.
The Spezialfonds mantle provides safety as well as sophisticated reporting to the investor in an institutional fund of funds strategy. The Spezialfonds vehicle underlies strict legal regulation and controlling entities include the fund controlling of the KAG, the depository bank, external auditing, and the German Financial Supervisory Authority (BaFin). A KAG provides the Spezialfonds investor detailed reporting on holdings, risk measurement and transactions at regular intervals and individualised reports ad hoc. The ultimate performance is reflected in the single share price of the Spezialfonds. The regular investor committee meetings which are documented by protocol are a venue for one-on-one reporting directly from the fund of funds manager. Investors who report according to the German Commercial Code maintain the taxation and balance sheet benefits of the vehicle.
Spezial fund of funds
The institutional investor now trades in the Spezialfonds manager for the Spezial funds of funds manager. The client, usually along with a consulting team, defines the trading parameters for the fund of funds manager, for example, asset classes and their bandwidths. Additional restrictions are defined such as risk potential, tracking error, foreign currency exposure or minimum rating.
When choosing a fund of funds manager, obvious criteria for selection are track record, skill of the asset management team and breadth of fund research. The quality of data and access to primary information are the most important aspects in the analysis of mutual funds. The domestic mutual fund vehicle, as explained above, is still targeting the retail investor. It offers in comparison to institutional funds scant reporting and less information from target fund management concerning investment policy. For this reason, the ability of the fund of funds manager to receive detailing reporting and information from target fund management plays a significant role.
There are two ways to guarantee access to necessary information. We can consider the fund of funds management of DekaBank as an example. DekaBank’s fund of funds management has a fund research team of 15 investment professionals at its disposal. Fund research works closely with the mutual fund management of the subsidiary Deka Investment and other strategic co-operation partners where detailed reporting is available and regular access to management is guaranteed. However, managing over €20bn in volume, DekaBank’s fund research team also accesses the highest quality information available from investment management companies globally.
In the shortlisting process, potential candidates must provide the fund research team with a detailed request for proposal through which information such as the investment philosophy (active/passive, growth/value/blend, tracking error, etc), the current and past investment policy, the current and past fund structure as well as information on the stability of the team. For example, the fund research function does not rely on publicly available data to assess a fund’s risk. Instead it analyses a time series of monthly holdings provided by the applicant. Fund research at Deka demands regular one-to-one’s and conference calls to develop a personal relationship with target fund managers. The reporting requirement is monthly information as to holdings, outlook and future strategy.
In all cases, personal contact with fund management ensures in-depth information concerning the investment policy, not only for the selection process but also on an on-going basis. Not all fund management companies are able to provide this information in full detail, or they may not want to for reasons of confidentiality. Therefore an important part of the process is to identify and work with those mutual fund providers who are able to provide the necessary transparency of data and information. Only then are the requirements met which fulfil the needs of an institutional fund of funds management strategy.
Claus Sendelbach can be contacted at firstname.lastname@example.org, +49-69-7147-3851, www.dekabank.de.