People climb mountains because they are there, but will German retirement savings funds use hedge funds just because a law makes it easier?
For most institutional investors the idea of hedge funds is more interesting than actually using them at the moment. This is partly because the ability to invest in them came into force in January.
Under the law, single-manager hedge funds or unregulated institutions can be sold to institutions and private investors through a private placement but only funds of hedge funds are allowed for public distribution.
Domestic funds of hedge funds can be publicly marketed whereas those domiciled abroad need permission from the German regulator, according to PricewaterhouseCoopers, a professional services firm. Funds of hedge funds, however, can invest in single-hedge funds with no restrictions on the number of non-German managers included.
There is also equal tax treatment for foreign and German underlying funds as long as the underlying holdings are transparent to the tax authorities. But hedge funds will need to regularly report to BaFin the net asst value of their shares and BaFin is keen to put stop-loss structures in place.
The hedge funds law followed pressure from asset managers and was tied into the wider law, the Investment Modernisation Act, which removes discrimination on foreign compared to domestic funds and enacts the Ucits III directive on cross-border investment vehicles.
However, although the law in Germany is now in force a number of issues have yet to be resolved, for example how and whether prime brokerages can act as fund custodians and what risk management systems need to be in place.
And with the regulator, BaFin, yet to license a group or resolve these issues (see page 40) even PwC advised clients to wait for the regulatory fog to clear for the regulated institutions, such as insurance funds, which might eventually be able to invest up to 5% of committed assets to hedge funds, and concentrate on private placements and unregulated firms.
Fog clearing is what some insurers are waiting for. The E135bn MEAG Munich Ergo Asset Management firm said it planned to use hedge funds. Dieter Wolf, managing director at MEAG, says: “Rules and regulations on hedge funds investments by insurance companies are expected in the second quarter of 2004 (within the modification of the Anlageverordnung). At this time, the German Financial Markets Authority (BaFin) will approve the first hedge fund of funds issued, according to the amended Act on Investment Companies. German institutional investors, as insurance companies or pension funds, will seek to diversify their risk by using hedge funds. Investors will be able to enhance their conventional portfolio structure due to the low correlation between hedge funds and traditional asset classes.
“Hedge funds will be one of the dominant topics in the German investment market of 2004 and 2005. By opening the gate for hedge funds, Germany went one step beyond what was required by the EU and clearly positioned itself as one of the few European countries at the forefront of the hedge funds industry.”
Hans Wilhelm Korfmacher, managing director of German accountants pension fund WPV, agrees liberalisation of hedge funds was positive. “It is interesting as an asset class because it is less correlated to normal asset classes. Fund of hedge funds are best structures for us but not at the moment as we only have a very small total of assets, as the law on pension funds was only passed two years ago, but assets are growing rapidly. The total in the fund could grow to E2bn in 10 years. For_institutions it could mean only 2 to 3% in this hedge_fund asset class – which is still a big number.”
Following the 2002 law giving all German workers the right to a corporate pension, estimates have put assets at E510bn by 2008. Goldman Sachs Asset Management said if 1 to 2% was invested in hedge funds, following an international pattern, then E100bn could be investors by Germans within five to 10 years. The German asset management association, the BVI, in January put the estimated size of market at E500bn, or 5% of assets, in the medium term.
Firms are already discussing how or whether to invest in hedge funds. Klaus Kirschenhofer of the E10bn Siemens fund, said it did not invest in them currently. “We want to make a decision in the first half of the year based on risk/return assumptions. As hedge funds are a skill-based asset class it relies on diversification so funds of hedge funds are the most probable way, although nothing is finalised until after the review.”
He adds there were specialised risks in hedge funds, such as working out when strategies stop working. “The market can be different from theory or are returns low because it was implemented the wrong way? It is not easy to quantify or identify prior to investment. I’m cautious of trading strategies and hedge funds are not an asset class as they all differ so much. You have to understand what you are buying. But the opportunities are to mix into other areas with low correlation, and relatively high risk/return.
“Investment banks present a success story but my view is that many people talk about hedge funds, many review it, as with private equity, but just a few invest. An investment decision is much slower to enact than thinking or discussing if to_invest. There is a big difference in losing money in a traditional way or same amount in exotic or specialised asset classes. Not rational but that is the way it is.”
Charlotte Kroher, an economist at HVB Pensionsfonds, agreed. “We might use hedge funds but as we only have one year of operating existence we have a very conservative investment strategy in equities and fixed income. They can be interesting but for the time being it does not makes sense for us. Hedge funds, by definition, means a wide range, where products are not strictly defined. I am sceptical on some of the promises, it is an illusion to have high returns, low risk – this is a recipe for gold.
“Diversity in product range should always be welcome, hedge funds spread risk. The law has scope for development when put into practice. Bafin will interpret the law and confirm what products are available.”
The first products, by London-based Man or Goldmans in institutional hedge funds or Cominvest, Dit, DWS, Lupus Alpha, Sal Oppenheim and Union Investment in also targeting the mass market, are likely to appear from this month. These products are expected to be more cautious investment strategies, such as market neutral or absolute return rather than highly leveraged arbitrage or macro strategies.
Despite, therefore, the optimism from the fund managers or big investment banks, such as Goldmans, that have an interest in boosting the market through their prime brokerage accounts and asset management arms, institutional investors are proving to be cautious and sceptical of the claims but are willing to learn more and possibly use conservative or funds of hedge funds.

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