1996 was a boom year for the German investment vehicle known as Spezialfonds. The influx of new funds into Spezialfonds broke all former records at DM62.3bn (up from DM36.9bn in 1995 and DM45.2bn in 1994). Not only was the growth in total volume impressive - up by DM87.2bn or 28.5% on 1995, but so was the number of new Spezialfonds set up. During the year 331 Spezialfonds were established - more than one every banking day!

The total volume of Spezialfonds reached almost DM400bn or practically 69% of the total volume of the German investment funds market by the end of 1996, up from 66% the year before.

Perhaps what is most surprising about the Spezialfonds success story is that non-German ownership, at around 1% of the total volume, is almost negligible. Yet investment in German stocks via Spezialfonds offers enormous advantages for non-German institutional investors in comparison with direct investment. Only through Spezialfonds can a foreigner obtain both part of the German capital income tax and the whole of German withholding tax when a favourable double taxation agreement exists - as is the case with France and the Netherlands, for example.

Assume that a non-German institutional investor which is tax-exempt in its domicile country holds German stocks in one case directly (see the left column of the graph) and in another case indirectly via a Spezialfonds (which belongs solely to the same investor, meaning that economically speaking the type of possession is absolutely equal). Also assume that the shares in each case produce the same amount of dividends, 100 (indexed). In the first case (direct possession) the non-German institutional investor receives 75% while the German fiscal authorities collect 25% as withholding tax and on top of that 42.86% capital income tax. 1, the non-German direct investor can improve his position by applying for a refund of 10 points of withholding tax, ending up with a cash dividend of 85% - but one has to take into account the way in which this is applied for and the resulting delay.

But that same non-German institutional investor, owning the same stocks indirectly via his own Spezialfonds, would receive not only the full cash dividend of 100, but also the 42.86% capital income tax. It is true that the Spezialfonds, after the end of its financial year, has to refund to the tax authorities the capital income tax originally received, but the costs of running the Spezialfonds can be deducted when calculating the repayment due; besides, the Spezialfonds will be able to hold the money for quite some time before making the repayment. Moreover, the cost elements of the Spezialfonds can be managed in an absolutely legitimate way by including, for instance, advisory fees which are paid to the investor himself for rendering investment advisory services.

The non-German institutional investor thus comes out of this investment through the medium of Spezialfonds with a dividend of at least 100, whereas in the case of direct share holding 85 would the utmost he could achieve. When in the case of investments via a Spezialfonds the possible advisory fee is taken into account, the non-German investor can arrive at a rate of 112 when a cash dividend of 100 was declared.

Given these considerations, it is hard to understand why the Spezialfonds vehicle is not used more intensively by non-German institutional investors to invest in German stocks. To repeat the message: non-German institutional investors should group their holdings of German stocks into a solely owned Spezialfonds to gain advantages that would not be otherwise obtainable.

The legal prescriptions of risk diversification for German investment funds, which also apply to Spezialfonds, cannot be regarded as an obstacle to such a course of action. The prudent investor naturally practises risk diversification when investing in a foreign market, whether it be directly or indirectly via a Spezialfonds. Spezialfonds must consist of at least 16 different shares, four of which can each make up 10% of the whole fund and 12 of which must not account for more than 5% each of the fund.

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