For the last five years the German market has undergone a process of modularisation process, with the asset management business moving to more specialisation and independence along the entire value chain.

Modularisation literally leads to a more ‘democratic’ market environment that creates additional opportunities for institutional investors and asset managers, independent of their size, which becomes less relevant in a modular industry.

While in the past institutional investors in Germany have had relatively little choice and flexibility in the selection of investment and administration solutions, this has now changed. Today investors are able to implement much more efficient structures, for example master KAGs that provide an efficient pooling platform, integrate a variety of players such as local and international asset managers, and ideally offer real value-added services.

An important prerequisite in a more modular environment is the skill to manage increasing complexity. Solid market intelligence providing insights and process skills are needed to integrate a variety of external solution providers for the sake of achieving a particular target. Based on their size and sophistication, there are investors who opt to manage this complexity on their own. Others will want consultants to assist them in their portfolio management. Modularisation has helped consultants get a strong foothold and latest research suggests they are becoming an increasingly dominant element in the asset manager selection process in Germany.

Finally, modularisation leads to greater transparency, which is crucial in building up and maintaining confidence in the system.

The democratisation process also leads to greater convergence among market participants as barriers to entry ease and give investors, service providers and asset managers access to new opportunities, diverse and specialised capabilities and better resources.

Network structures have enabled international as well as local asset managers such as boutiques to better tap potential investor sources either directly or through multipliers such as investment consultants. Consultants source asset manager solutions from international markets and piggyback investment companies that have so far even not thought of serving German clients but feel compelled to do so, based on their selection to advise a mandate.

International investment consultants are increasingly interested in building up local capacities or buying into existing local structures, as seen in the case of Rauser Towers Perrin, Bode Hewitt and, most recently, Watson Wyatt’s announcement of its intention to form Watson Wyatt Heissmann.

Given the future importance of the pensions business, pension and investment consultants will gradually converge in order to provide end-to-end services to clients. This will lead to local and international strategic alliances among complementary consultants that are specialised in distinct niches or target groups, and to further mergers and takeovers between consultants. The Europeanisation and internationalisation of clients will increasingly demand cross-border solutions that will impact each and every module within the value chain. This will also encompass investment consultancies whose main business so far has focused on the local market, such as Feri Institutional Advisors, Alpha Portfolio Advisors and RMC.

Internationalisation has become a major option for German players that over the next few years will increasingly build up capabilities for foreign markets. Even for master KAGs that are embedded in an international organisation, moving abroad could be a viable option in order to diversify business risk.

A recent communication from Deutsche AM’s master KAG suggests an intention to follow local clients in their international endeavours. Local players are increasingly pitching for international mandates and search for potential alliance partners abroad to offer their complementary services.

Modularisation also leads to convergence. This can be highlighted by several ‘visible’ trends in Germany.

First, the institutional and classic retail businesses are converging. IAS/IFRS accounting standards and the need of institutional investors for more flexibility are leading to substantial investments in mutual funds - passive as well as active. Asset managers that have traditionally run separate units to serve target groups are being forced to adopt new organisational structures to cope with the changing needs of clients. The occupational pensions business and the increasing penetration of DC schemes is a good example of institutional clients and their members investing increasingly in mutual fund-based solutions.

And the actors in this process are also changing. Whereas traditionally treasurers of corporates had to be targeted, asset managers active in the pension business have now to cope with management as a whole - human resources and works councils, for example - to get things done. Therefore the skill sets have to change as traditional relationship management is no longer sufficient to meet the needs of a changing environment. International players like Fidelity, with a solid track record in the pension administration business as well as investment management, have built up dedicated capacities locally to cater for this change and to meet tomorrow’s requirements.

Second, institutional investors and asset managers are converging. Fiduciary asset management - a topic that asset managers, investment consultants and German master KAGs will increasingly focus on - is certainly a result of this process. Master KAGs in particular have a stronger understanding of managing network structures and seem to be better suited to do so, perhaps in alliance with consultants that are strong in asset manager selection.

Based on their growing sophistication, major investors will increasingly insource external mandates, taking potential business away from asset managers. Mergers among pension entities leads to greater bargaining power and, as we have seen in other European countries such as the Netherlands, this materialises in pension administrators with internal investment and consulting capabilities.

Investment consultants will increasingly face competition from asset managers offering free services, and asset managers will face competition from investment consultants offering multi-manager products, as with Mercer’s launch of MGI.

In the pensions business particularly, with institutional investors such as pension entities offering their services and solutions to members abroad, asset managers will increasingly be faced with some form of competition from existing clients.

Third, active and passive strategies are converging. Investors are increasingly combining active and passive strategies in order to profit from the best of both worlds. Furthermore, we are seeing the emergence of a new category, strategic or fundamental indices where active strategies are passively tracked with fees well below active mandates but still higher than passive ones.

Enhanced indexation approaches are also gaining in importance, thereby closing the gap even further. The move towards passive, enhanced, and strategically managed vehicles is especially visible in liquid markets. The success of investment companies such as iShares are certainly an indicator for this.

Fourth, hedge fund-like management styles and traditional investments are converging. In Germany the term hedge fund sometimes prevents investors from investing in this asset class, but the strategies of hedge funds are increasingly found in traditional long-only portfolios. 130/30 strategies, shorting in general, leverage in ordinary mutual funds that are allowed under UCITS (200%), and the extensive use of derivatives are certainly signs of that.

Fifth, the business of asset managers, insurance companies and investment banks is converging. While all three parties have a solid track record of competition, in a modular environment they increasingly value the complementary skills of their counterparts.

Insuring longevity risk and providing guarantees are certainly not the core competence of asset managers, but are worthwhile areas for co-operation with insurances and investment banks. Demographic shifts, changes in occupational and individual pension provision are all areas where co-operation increasingly plays a role. Furthermore, securitisation of strategies through the usage of certificates is a domain well occupied in Germany, with roughly €120bn outstanding in certificates (structured notes). However, this convergence also affects the sales side of the business as traditional competitors’ services converge, increasingly targeting the same investor groups.

Much is taking place in Germany, and from a modular perspective this is true for most European and international markets. Modern technology and processes open up new opportunities and it is not by chance that investors are increasingly developing a taste for quantitative investment styles that tend to perform well in rational markets. Today’s strong competition will increase even more, with existing competitors, alternative products providers and new entrants moving into the domestic market.

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

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