Demystifying the outlook

The investment consultancy business is undergoing changes. Murat Ünal (pictured right) examines the landscape

There is a German saying that ‘you should never trust a statistic that you have not forged yourself'. This idiom is relevant to the German investment consulting landscape in Germany where there is not yet sufficient transparency. There is lots of data in the market but it is unclear whether, for example, it covers just the German market or include selections for Austrian, Swiss or other international clients, or whether the amounts have been exaggerated.

However, we estimate that investment consultants in Germany carried out some €23bn-worth of asset manager selection last year. And it does not matter whether or not this total includes business outside the country because, after all, wherever they are from, institutional investors looking for professional advice are interested in the same things: a consultancy's track record and expertise and whether it is in a position to meet specific needs.

The German market is quite regulated and customer oriented, requiring a profound knowledge of the framework within which corporates, occupational pension trusts, foundations, church-related investors and other institutional investors exist.

There are several investment consultancies providing services to the German market. But there are also some possibly surprising absences. This is because while some major players like Mercer or Watson Wyatt are active in manager selection, others either have no or hardly any such activity or, as in the case of Roland Eller Consulting, focus on specific target groups like savings banks and offer related services like managing treasury pools.

When choosing a consultancy large corporates might find international players like Mercer or Watson Wyatt more suitable. They are active internationally and like to provide an end-to-end service - that is, throughout the entire process including the development of tailored pension vehicles and plans, HR services, ALM and manager selection.

Mercer boosted its position in Germany with its takeover of well-established pension consulting firm Höfer Vorsorge-Management at the beginning of the year. The deal gave Mercer the top market position in Germany by employee size, broadened its range and will enable it to cross sell asset manager selection services. It also expanded its reach from Düsseldorf, Frankfurt, Hamburg, Munich and Stuttgart to additional offices in Berlin, Karlsruhe, Leipzig, Mülheim and Wiesbaden, and lifted its number of employees in Germany from 300 to over 500.

Similarly, Watson Wyatt's 2007 merger with Wiesbaden-based Heissmann, to form Watson Wyatt Heissmann, gave it access to a broader corporate network.

Despite the difficulties in integrating newly acquired entities, these acquisitions were definitely a good move given that corporates and their pension vehicles are one of the most relevant target groups with assets under management that will grow substantially in the years to come.

The worlds of traditional pensions consulting and investment consulting are fused and this convergence is assisted by the growing complexity that clients, especially international clients, are faced with when managing pension vehicles in Germany. Pension and asset pooling are certainly growth areas in this context.

However, for the local market the linking of Mercer and Höfer or Watson Wyatt and Heissmann was not a new development. A decade earlier Heubeck, a major pension provider, and local consultancy Feri created a joint venture, Heubeck-Feri, which was intended to provide a holistic service with an initial focus on the local market.

The challenge behind this joint venture was that with the focus being very much on the local market it could not provide the international resources available to a company like Watson Wyatt or a Hewitt.

A client like E.ON, for example, might work with Heubeck-Feri for issues concerning the German market but the moment it starts to move outside Germany's borders and being exposed to pension entities in the UK, Switzerland or the Nordic countries, such a local player finds its core competencies are no longer sufficient but the international players already have such competencies as a basis.

However, while international players have analysts in the UK and US to provide a platform for their local businesses, local players generally have a better feeling for local asset managers that might not necessarily be rated in a global database.

And there is the prospect for the creation of a substantial new market in Germany following a recent debate among market participants and the government about the creation of German funded public pension funds. Until now the public pension sector has been primarily a pay-as-you-go system, unlike Switzerland, for example, where the pension funds for the Canton of Berne or the City of Zürich are major players.

But there has been increasing discussion regarding creating capital market or investment-based solutions like pension funds for public entities. So far 13 of the 16 Länder have decided over the past two years to create state pension funds, the most recent being Brandenburg. Initially they will be very small; in February Brandenburg said it had a surplus of around €403m in 2007 that it would set aside to secure its pension liabilities in a new fund by the end of this year.

Nevertheless the area has huge growth potential. There are some €200bn of public pension assets in the Swiss second pillar, while in Germany there is not yet a real public pensions second pillar.

Feri Institutional Advisors is a local investment consultancy pioneer and through the incubator effect has played the role of ‘father of the industry' as people have left to take key positions in the German offices of asset managers Threadneedle and Aberdeen Asset Management, and consultancies Faros and Watson Wyatt, and have thereby generally contributed to a growing sophistication of the market. Feri's implemented consulting approach and advisory business, which caters for multi-asset and multi-manager mandates, plays a significant role in the market.

However, specialisation has its value. This can be seen in the activities of consultants such as Alpha Portfolio Advisors and Faros. Faros' high-alpha approach to manager selection and Alpha's performance fee only-based model are certainly differentiating factors and models that can be further exported to other markets.

And German consultants can add value when it comes to manager selection in foreign markets. This is particularly evident in the Swiss market where Alpha recently won a large manager selection mandate from a corporate. German penetration is assisted by the custom among key Swiss players like Ecofin and PPCMetrics of charging asset managers significant sums to be included on their database, a practice that has not been followed by German consultants.

One should not overestimate the impact of consultants in Swiss manager selection as the level of investor sophistication has led to greater insourcing of management activities and of passive mandates. And local consultants have a strong advantage in the auditing area.

However, the ongoing discussion in Switzerland about separation of auditing and manager selection activities presents an area that German and international companies can grow into because, as Swiss consultancy Complementa points out, such a separation of functions helps to reduce conflicts of interests and adds a third-party perspective.

Other practices, for example in the UK where two consultancies can pitch for their preferred asset manager in a beauty parade rather than just one, are certainly something that could develop at some point in the future.

From an evolutionary perspective the German market is still in its early stages but, depending on the size of the investor, it has now become customary to have consultants pitch against each other for manager selection mandates.

However, the growing sophistication of investors has also led to more specialised demand for other asset classes, for example alternatives, where consultants can clearly offer added value.

Identifying new opportunities

The last six years have seen substantial changes in the German market place. A country traditionally built on a system geared towards creditor protection is shifting towards an environment where investor orientation is increasingly becoming the focal point.

This is underlined by both the adoption of IAS/IFRS standards among major institutional investors such as listed corporates and the emergence of a ‘fiduciary concept' for institutional investors where the role of transparency, proper governance and the best interest of beneficiaries come to the fore. Of course, legal convergence driven on a European scale but also internationally is aiding this process and opening up significant new opportunities.

Germany is undergoing structural changes in the institutional business that markets such as the UK and Switzerland have already gone through. These changes include development towards a strong second pillar and the emergence of an increasingly modular market where specialised participants offer their different core competences.

If tackled correctly and in a concerted manner, this could provide a strong case for pension pooling activities. Already, the increasing funding of pension liabilities is opening up new opportunities for asset managers and providers.

Whereas large pension markets such as the Netherlands are highly competitive, the German markets can still be seen as emerging and it still offers substantial opportunities to new market entrants who have a core competence that investors are looking for.

Aided by multipliers such as investment consultants, the entry barriers for foreign asset managers have fallen and investors such as corporates with their pension vehicles, occupational pension entities for the liberal professions, savings banks' treasury departments and foundations are increasingly opening up to new market entrants.

In a world where increasing integration also means greater stability the hiring of a foreign asset manager can also mean diversification of asset manager risk and access to different perspectives and views. For the asset management company it means diversifying its investor base and increased stability.

In the first quarter of 2008 at least 30 asset management companies and fiduciary managers were planning or executing an entry into German institutional business.

Boston-based MFS Investment Management, for example, is building up its local institutional capability with a long-term focus. It is currently establishing a five-strong relationship manager team devoted to German-speaking markets from a Munich office that will drive its institutional business.

From a local institutional investor's perspective the growing supply of asset management services and dedicated local teams should be very welcome because it creates a number of new options which at the end of the day will serve the investors' needs.

Asset managers that never thought of actively entering a market are assisted not only by international investment consultants but also local consultants that through their manager selection process act as multipliers and match investors with relevant providers. In 2007 some €23bn in manager selection was performed by the nine key investment consultants and our projections suggest that this number could increase to €26bn in 2008.

For foreign asset managers that consider selectively targeting international markets such as Germany a consultant-focused approach among others gives access to a diverse group of investors in an efficient way.

Denmark-based Carnegie Asset Management has selected the UK and Germany as future markets beyond its traditional Nordic focus. Over the last four years Carnegie has hired international relationship managers who have worked in the German-speaking markets.

New alternative asset managers from Switzerland, investment companies from the Gulf region, eastern Europe, Asia-Pacific and elsewhere will further change the German institutional landscape for the better, giving local investors more genuine opportunities to diversify their portfolios and, through setting new standards, to raise the bar for existing market participants.

Above all the increasing diversity will add to the professional landscape in Germany and thus strengthen Germany's role as a financial centre. We therefore welcome this increasing integration that, through higher interdependence among market participants, will also bring about greater stability for capital markets as a whole

Murat Ünal is CEO of Frankfurt-based consultancy Funds@Work AG