Without any promotional fanfare and just as discreetly as Swiss private banking, a market is emerging in Germany for institutional invest-ors. Special funds (Spezialfonds), are designed specifically for the institutional market and are not on offer for the general public. At the end of 1996, there were more than 2,900 special funds in existence with total assets exceeding DM390bn ($230bn).

The funds are primarily sold direct via 45 different investment companies, owned mainly by the banks. The German universal banking system has proved very helpful, with the strong branch networks and institutional contacts - consequently, these institutions have taken the largest market share. Due to the highly competitive nature of the market, management fees tend to be significantly lower than in the Anglo-American market.

So, why have these 'Specialfonds' grown so strongly since the early 90s? Eight main advantages are frequently cited for this product: professional portfolio management, security, efficiency, cost effectiveness, tax advantages, accounting, reporting and liquidity management expertise. One look at the heterogeneous client profile of the special funds market shows that each client ranks these product advantages in a different order.

More than 25% of the fund sponsors are small businesses, charitable and other foundations, as well as small pension funds. These organisations evaluate whether to set up their own active and international asset management operations or to outsource. Low custody fees and simpler book-keeping are two reasons for employing an external special fund manager. The fund beneficiaries can gain access to their funds through the sale of shares in the fund at any time. Typically, this group is highly risk adverse and conservative, and is attracted, amongst other things, by the wide-ranging security mechanisms pro-vided by German law governing capital investment companies.

Over 50% of the fund shareholders are insurance companies and banks, mostly with their own fund managers and expertise. When such institutions initiate their own special funds, their goal is to maximise the accounting advantages and exploit the flexible taxation of profits. A company's earnings can therefore be subsidised via the variable payout of profits. The lower-of-cost-of-market principle observed in Germany also means that hidden reserves can be built up in conjunction with retention of earnings. The previous well-known tax advantages for foreign investors have been sharply reduced following revision of German tax legislation and on their own are insufficient incentives to establish a special fund.

Managers of special funds are eager to emphasise the professional management of portfolios and outperformance relative to the benchmark. However, surveys have indicated that very few German investment companies do in fact consistently achieve above-average returns. Greenwich Associates, for example, established in their latest survey on the 1996 special fund market, that only one investment company achieved a clear lead as regards confidence in future performance and satisfaction with its track record. It is interesting to note that, according to this survey, the 130 largest sponsors of special funds ranked investment performance as only the third most important criteria after investment philosophy and competence of portfolio managers.

Leading studies indicate that the market will grow by almost 10% per year through the year 2000. On the basis of sharp margin reduction, a phase of consolidation among the players can be expected. At the same time, greater emphasis will be placed on the quality of service to customers. Claus Sendlebach is director of Commerzbank Investment Management

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