German institutional investors are shifting to bond investments as interest rates increase, while changing their stance on alternative asset classes, including real estate, to diversify their portfolios, according to Universal Investment.
“Asset owners are finding bonds appealing again, many opt for new investments to directly invest in government bonds,” chief customer officer Katja Müller told IPE.
She added that asset owners will also strongly focus on US and European equities, in addtion to bonds, to diversify their portfolios.
The allocation to bonds in the portfolios of institutional investors has increased by 1 percentage point, as of June, compared with the beginning of the year, as a result of a turnaround in interest rates, to reach 38% of total allocated assets. Equities remained stable at 23.4%, according to Universal Investment’s latest institutional investor analysis.
Within the fixed income segment, corporate bonds (28%), government bonds (28.69%) and covered bonds (9.41%) are the most invested sub-asset classes, the figures show.
With bond yields rising, investors are now looking at alternative investments with a different lens, taking a more cautious approach, Müller said.
Previously, alternative investments were very appealing returning 5-6%. With bonds back on the table the risk-return profile of investments has changed, but alternative investments are still on institutional investors’ minds, especially private debt, as they prioritise portfolio diversification, she added.
Despite a changing approach, alternative investments continue to play an important role in institutional investors’ portfolios in the long-term, with private equity, private debt and real estate making up 18.1% of total assets at the end of June, according to the firm’s data.
Universal Investment expects institutional investors and asset managers to offer bonds, ESG and infrastructure funds on its platform, it said.
Assets administered in securitisation, equity and debt structures, and hedge funds, within the alternatives universe at Universal Investment have steadily grown in the past decade to reach €93.5bn in the first half of this year. In real estate Universal Investment is observing investors acting carefully, as the market is slowing down.
Müller said that institutional investors are currently “rather cautious about making new investments in German real estate and want to invest more in Asia and North America”.
Allocations to German real estate are set to decrease strongly by 12 percentage points to 57%, while in rest of Europe the average allocation will rise slightly to 26%, according to Universal Investment’s 2023 real estate survey.
Institutional investors, instead, plan to increase allocations to real estate in North America (9%) and Asia/Pacific (8%), the survey showed.
Legal basis for investments
Germany has laid the legal ground to potentially mobilise private capital and becoming more appealing for funds, with the Fondsstandortgesetz (FoG) – the Fund Location Act – and the Financing for the Future Act (Zukunftsfinanzierungsgesetz).
“The Fondsstandortgesetz provided [investors] a broader range of close-ended funds and long-awaited facilitations in infrastructure and real estate investments, while the Zukunftsfinanzierungsgesetz has just recently clarified, for example, the regulatory issues around real estate funds and increased investment opportunities in renewable energy,” Titus Noltenius, head of legal fund governance at Universal Investment, told IPE.
Universal Investment considers those being important steps to further strengthen the German fund industry, by establishing competitive rules, while seeing room for improvement on infrastructure funds.
This year also marks the anniversary of the German investment code (KAGB), that entered into force in July 2013, creating a common regulatory framework for open-ended and close-ended funds, establishing clear rules for the market of alternative investments.
“The KAGB led also to an additional boost for fund administration platforms. It provided a uniform regime and Germany has become competitive with other fund markets like Luxemburg,” Müller explained.
Assets under management in the fund industry have doubled in the past 10 years and fund service platforms such as third-party management companies have benefited from the uniform rules, increasing requirements from clients like institutional investors and asset managers, she added.
Pension reform an opportunity for asset managers
The German government plans to reform the first pillar pension system to allow investment in equity, but also in infrastructure and private equity, initially relying on the asset management skills of the nuclear waste management fund KENFO.
A group of stakeholders set up to propose reforms for the third pillar pension system in Germany, Fokusgruppe Altersvorsorge, has also recommended offering savings accounts to invest in funds, private equity and real estate, to achieve higher returns for savers instead of Riester-Rente contracts.
The cabinet has yet to introduce a bill, announced for this summer, to reform the first pillar, as criticism against the so-called Generationenkapital concept mounted within the governing coalition and unions.
“It is interesting to see if the government will succeed to implement appropriate legislation to reform the pension system,” Müller said.
She added: “A 5-10% allocation of pension assets for investments in the first pillar is a lot of money – this would be an interesting topic for our industry. The assets in the first pillar have to be managed and kept by professionals, and this affects the fund industry.”
In the third pillar, Müller believes instead that more competition among providers won’t lead necessarily to lower costs, especially with regard to inflation, rising IT costs, staff, and benchmarks.
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