Typical German portfolios are no longer plain vanilla, domestics with a fixed income bias. Over the past couple of years institutional investors have moved into more adventurous asset classes and German managers now have a pan-European and, in many cases, international outlook. Partnering a more complex approach to investment management is a greater role for consultants and, although never as popular as in the UK and US, Germany’s consultants are picking up more and more business. German insurance companies are hopping on the bandwagon, with many launching their own KAGs. Unsurprisingly this has attracted criticism from local managers who feel some of the smaller companies will regret the decision.
According to Michael Korn, global head of institutional business at Dresdner Asset Management, Germany now thinks in European terms. The move from a domestic orientation to pan-European is over and Germany is moving to a more international approach: “We can feel the influence of Anglo-Saxon competitors who are generating the appetite for non-European exposure.”
Friedrich Schmitz, head of asset management at Commerzbank, is convinced growth will fall this year due to the slowdown in equity markets. Over the past two years the institutional side has seen annual inflows averaging 30%, the retail side about 23%. Schmitz says Germans have adopted an equity culture and investors are moving into European stocks. “People are more sophisticated now and are more interested in high growth areas,” he says. This naturally involves investing abroad. “If you’re interested in technology for example, you have to invest abroad,” he says. In Germany the institutional split is now 55% in equities, 26% in fixed income and 18% in money market products. “This has changed dramatically over the last five years. It’s still behind the US but in another two or three years it’ll be at the same level,” he predicts.
Peter Koenig, executive director at Morgan Stanley Dean Witter, says the introduction of the euro has produced a shift from balanced to core satellite: “We’ve seen more demand for specialisation and clients don’t expect their manager to manage all the funds.” It has also led to a reassessment of boundaries with local investors now considering Europe rather than Germany as their domestic market.
Credit Suisse Asset Management who has run a KAG since 1987 and who runs DM6.5bn (e3.3bn) in assets concentrates on Spezialfonds and has seen new business of DM900m in the last year. According to Claus Sendelbach, director of institutional sales, their market has a clear split. The specialist mandates constitute up to 25% of business and typical clients include pension funds and public funds with a clearly defined and accepted benchmark. Sendelbach says there is a continuing change on the client side: “They are asking for a well-defined investment philosophy and a transparent approach to investing.”
Passive management is also enjoying a renaissance. On the institutional side, it accounts for about 8% and this is forecast to rise to 10% in the next two or three years. Commerzbank’s Schmitz believes it will reach this target sooner and that on the continent, passive mandates will grow quicker than active ones. “If you look at the benchmark over 10 years it’s very hard to beat it,” says Schmitz. According to Towers Perrin, many clients want advice on selecting a benchmark. Historically, absolute return has subjugated benchmarks and, according to Menssen, client’s benchmarks often appear to be selected arbitrarily. Many clients have a more complex investment strategy and therefore need a more relevant and complicated benchmark.
Hans-Juergen Reinhart, managing director of RMC consulting, agrees, saying two years ago it was far harder to talk about strategic services. “We’ve shown the direct link, we’ve shown why it’s necessary to have clear benchmark programming,” he says. RMC offers first and foremost asset liability studies, but also offers manager search and risk analysis. Reinhart says it has 10 clients for which it organises the whole investment process and between them these 10 have DM15bn.
Typical benchmark changes include an increase in the equity share and an allocation of between 3% and 5% in alternatives – emerging markets and high yield bonds. “We recognise the willingness of investors to invest in alternatives,” says Menssen at Towers Perrin. Historically insurance companies have with ease returned 7%. Over the past 20 years, long-term bonds have averaged about 8%, now yields are at best about 6%. During lean years the insurance companies have tapped hidden reserves, but many are running low and have had to branch out as 7% on a plain vanilla fixed income portfolio is impossible. According to Horstdieter Grohs, European marketing manager at Foreign & Colonial, institutional investors are beginning to invest in emerging market equities. Demand for high yield bonds is also taking off in Germany and F&C is recommending up to a 15% portfolio share.
One local manager says most institutional investors are on their 30% equity limit and there is pressure on the government from the BAV to relax the restriction, something likely to happen over the next two years. Germany’s insurance industry is lobbying for a 50% limit. “We have to go step by step. Forgetting the limit is the nirvana but we’re very far from that. Something has to happen or the insurance companies are in big trouble as they are still offering projections in excess of 7%,” they say.
Frankfurt’s Neuer Markt has benefited from the switch to specialised and has attracted considerable funds with asset manager Julius Baer leading the way. According to managing director Patrik Roeder, Julius Baer runs E5.5bn in equities and balanced mandates out of Frankfurt focusing on small and medium-caps and the Neuer Markt. Creativ, a E250m fund launched in December 1999 and has doubled to date. Of Germany’s 4,000 funds for sale, Creativ is ranked number one. Creativ invests in undervalued growth stocks, the majority being European small caps (85% Euroland/7% Switzerland/5% US/ 3% elsewhere). The fund also invests 10% in private equity.
Kurt Ochner, Baer’s chief investment officer, has good contacts and a great reputation and is key to the success. Manager loyalty also contributes – Baer’s KAG was founded in 1996, since when nobody has left. Roeder says it’s unrealistic to expect the huge growth in TMTs to be maintained but is convinced the sector remains highly attractive. “Until March you could pick almost anything now it’s only 20% of stocks that are worth it. These 20% are much more attractive than their traditional counterparts,” he says. With Julius Baer’s larger clients there has been a significant switch to specialised mandates. “A lot of clients are disappointed. It’s very difficult to find an asset manager who’s good at everything” says Roeder.
Klaus Mossle, managing director at Deutsche Asset Management, says investors are switching to high yield bonds as the market chases higher coupons. In principle, Deutsche and its clients would like to see the 30% equity limit abolished and such a move would have great consequences, particularly for the smaller pension funds as they would need plenty of strategic advice. According to Dresdner’s Korn the German government has issued less debt in the last year and corporate issues have risen sharply. “Private debt is almost substituting government issuance and this puts additional pressure on the manager,” he says. Most clients are sticking to BBB or investment grade. “Very few are willing to go below investment grade. Very few have any experience in credit risk, and they are very reluctant to move below,” he says.
Flemings is branching into small caps in Europe and the big success has been the launch of life science and biotech funds run as a Sicav in Luxembourg. DG Panagora, the joint venture between DG Bank and America’s PanAgora Asset management, has launched a purely quantitative approach, a brave move given the conservative nature of German investors. Marc Bechtel, DG PanAgora’s executive manager, says they have raised DM1bn independently on top of DG Bank’s DM1.8bn seed capital. Bechtel admits selling the quantitative structured approach has been hard but is confident the venture will be a success and since inception, their equity fund has outperformed the Stoxx 50 by an annualised return of 3.1% as of August. At Commerzbank Schmitz says private equity has become one of the major focal points for clients and over 4% of German institutional money is invested in private equity.
Foreign asset managers have yet to make inroads into the German market, despite the proliferation of investment styles and diversification. According to Invesco’s figures, foreign managers capture about 10% of the German market and Bernhard Langer, Invesco’s CIO, is convinced the stranglehold local managers have on the market will prevent this rising. Germany’s so-called big five – Deutsche, Dresdner, Commerzbank, Hypovereinsbank and Allianz – control over two-thirds of Germany’s asset management. “It’s very difficult for foreign managers because domestic banks still have the relationship with the corporates… Deutsche and Commerzbank etc have such a strong brand that it’s hard for foreign managers to break in,” says Menssen at Towers Perrin.
Admittedly the number of foreign KAGs has doubled in the past four years but the Spezialfond market has grown 25–30% therefore any increase in market share is nominal rather than real. Commerzbank’s Schmitz describes Germany as a very decentralised market, one where you have to travel extensively to meet people and to make presentations; you also have to speak the language. German institutions also have a very close relationship with their managers and at present foreign managers have 10% of institutional business, 5% of the retail side. “Eventually US and international asset managers and consultants will learn and increase their share but as the German market is growing at about 30% per annum there is plenty of room,” says Schmitz.
If foreign managers do break into the market they will relish the funded pension scheme which finally seems a reality. According to Matthias Klein, managing director of Metzler, there’s huge potential for a defined contribution system in Germany and recently a consortium of banks and two of the largest associations presented the government with a 10-point proposal for a funded pension scheme. Deutsche, Dresdner, Commerzbank, Morgan Stanley Dean Witter, Metzler and DEVIF, the Spezialfond for the German Co-operative system teamed up with the BVI, Germany’s association for mutual funds, and the BDB, the association for private banks, tabled the document.
Germany’s BDI, representing German industry, and DIHT, the joint council for the chamber of commerce have both put their name to the project and signatories are lobbying other groups. Klein says the feedback has been encouraging and he is confident Parliament will change the law assisting PAYG with a capital-backed system like the American 401K. The 10-point plan is unique in that it is the first time the banking and finance associations have reached a consensus. Germany’s insurance industry is well represented by a coherent, well-organised association. Banking and finance associations are numerous and historically have been unable to agree on the structure of a funded system.
Dirk Popielas, executive director of the pension services group at Goldman Sachs and an ex-Mercers man says the 10-point proposal is important as it’s the first time finance associations and banks have reached a consensus. Government feedback has been extremely positive, with Chancellor Schroder agreeing to reform second pillar schemes. A government white paper on second and third pillar provisions should be published in October and the outlook is promising. Says Popielas: “One of the advantages for the banking sector is that the European scene backs a level playing field.”
Klein says the change would have been inconceivable a year ago but that reform, particularly to the tax system, has facilitated the changes. The government recently announced the top rate of tax will fall from 53% to 42% by 2005. Starting tax rates will also fall to 15% from 20% over the same time period and dividends tax is being cut from 36% to 25%. “This has been the dambuster for the German market… this will help defined contribution in Germany,” says Klein.
On pension fund reform, the government is divided. The department of employment is old fashioned and against change. The economic department is forward thinking and is proposing something along the lines of the American 401k system. Banking and insurance lobbies have differing agendas and earlier this year the insurance lobby managed to convince the employment department that life insurance was the most sensible approach. “At the moment the insurance lobby is ahead but in the end there will be available a variety of investment vehicles,” says Invesco’s Langer.
At present contributions into Pensionskassen are taxable while benefits are tax exempt. If the economic ministry gets its way, contributions will be tax exempt and benefits will be taxed. Interestingly, there appear to be no partisan splits, instead cross-party agreement. Germany’s next election is in two years and Langer says the government needs to push it through before. Potential consequences are colossal since in Langer’s estimation, forty million Germans would set up savings accounts.
With the Spezialfond market was booming last year, many insurance companies are launching their own KAGs and Rudolf Siebel, director of policy at the BVI, says they have had numerous applications. The majority of KAGs are private banks but ten or twelve now belong to insurance companies. Among German asset mangers the feeling is that larger insures like Allianz, Munich Re through MBAG and AXA Colonia will succeed but that the small and medium-sized insurance companies have made a mistake. Estimates of the funds necessary to maintain a KAG vary from E3bn up to E20bn. Combined with significant start up costs, many managers feel smaller insurance companies will rue setting up on their own. “Some of the insurance companies will come back and close their KAGs as their expectations might not be realised,” says Klein.
Feelings are mixed towards the threat these new KAGs pose traditional asset managers. Invesco has $17bn assets under management in continental Europe, of which $7bn is in Germany. Langer feels the Allianzs and Munich Res are a threat but that smaller insurance KAGs will wither on the vine. “The bigger ones have a really good distribution network and if they manage this well they will provide big competition,” he says. For the smaller ones, asset management will prove unfeasible. “It’s too expensive for the small and medium-sized insurance companies and they will repatriate the funds.”
Deutsche Asset Management has lost E10bn in assets largely due to Munich Re setting up its own KAG. Mossle says Deutsche doesn’t consider Munich Re a threat. First, they have to convince investors they have a first class asset management team, something he admits they are likely to achieve given time. “They also have to convince external clients that Munich Re’s primary focus will not be on their large internal clients,” he says. Instead managers like Merrill Lynch who, according to Mossle, have made a conscious effort, pose more of a threat.
Korn, Dresdner’s global head of institutional business, disagrees. Dresdner has lost over E5bn repatriated by insurance companies. Insurance companies have traditionally been staples for DBI and Korn says the losses are a blow. “Now the big insurance companies are delivering asset management we’re facing a double challenge. We’re not only losing them as a client but we’ve now got them as a competitor,” he says. Nevertheless Korn calls this a structural adjustment and says it should be over by the end of the year
Off the record, others are downright scathing about insurance companies’ efforts to move into asset management. “The problem is that many of their own asset managers are losing money,” says one local in the market. Menssen at Towers Perrin doubts larger KAGs like Allianz will capture mandates from other insurance companies. Sending assets to a competitor is, as it were, feeding the hand that bites. Many believe the mid-sized insurance companies have overestimated the capability to generate third party money. “With the exception of Allianz, if you look at third-party amounts, it’s tiny,” says another. “In the market there’s a belief it boils down to the remuneration of the investment teams. There’s a feeling that if Allianz has done it, it’s worth doing it.”
Universal, a KAG with close ties with foreign managers, runs 180 Spezialfonds with assets of DM47bn. Bernd Vorbeck, Universal’s managing director, says insurance KAGs pose no threat and he believes many of the smaller insurance KAGs will fold over the next two to three years. He is even more sceptical about the larger companies’ ability to raise third-party capital. “Allianz is trying to portray itself as an asset manager but in my opinion most of its money is its own,” he says. Despite the naysayers, Morgan Stanley’s Koenig believes Allianz will eventually pull it off. “Given their strengths and resources, I expect to see them there in three or five years,” he says.
German asset management has changed significantly in the past 18 months. Many of the changes are out of necessity- introduction of the euro and the 30% equity limits, for example, and there are some managers who believe although the market has embraced other investment categories, it isn’t entirely happy with it. “The honest answer is that clients don’t actually believe in alternative investments,” says a consultant. Even if the insurance KAGs establish themselves and even if there is a privately funded pensions scheme, the German market has yet to face a crisis.
Says one local manager: “German investors at heart aren’t equity investors. If there’s a crash, German investors will go back to fixed income and the old savings funds. Remember, the so-called equity culture is only one year old.”