Magazine Issues » May 2008


Equity investment is at an all-time low in Germany and the fund management opportunity, huge though it could be, remains static as savers shun risk. But far-reaching changes to investment laws may change the landscape, finds Fiona Rintoul.

Sometimes it feels that nothing much changes in German fund management and that nothing much ever will. Take distribution. Latest figures show that fund distribution in Germany is dominated by banks to the tune of 72% of market share (see chart, p14). This is not radically different from the position ten years ago – or even 20 years ago.

But, of course, a headline figure like this reveals only a fraction of the truth. In reality Germany, which is sometimes described as a sleeping giant in fund management terms, has seen its bank distribution change radically because the banks have moved towards open architecture and guided architecture, meaning they are now substantially more open than they were ten years ago.

For fund managers, the basic business opportunity also remains unchanged, at least on the surface. Characterised by a large population (the largest in Europe) with a high level of affluence but a significantly underfunded pension system (contributions form just 16% as a percentage of GDP compared to 120% in Switzerland) the industry is aching for public and private sector pension funds to move towards greater funding. 

A long wait
The industry’s wait has been a long one and with equity investment at an all-time low – according to Deutsche Aktieninstitut (the German Equity Institute) – the wait looks set to last a while longer yet. Regulations have led to pension plans holding large amounts of low-risk bonds, while the zertifikaten product offered by banks distracts retail investors from equity funds.

That's one reason why German groups are looking outside of their home market.  A rock-solid German stalwart such as Union Investment, the fund manager for the German co-operative banking sector, for example, now has a joint venture with Bank of East Asia in Hong Kong and has businesses in Poland and Hungary. It is also pitching for institutional mandates in countries including the UK through relationships established with consultants, and has e7bn (£5.51bn) under management for foreign investors.

Significantly, where its local business is concerned, Union is also starting to target German investors outside of its traditional co-operative banking catchment. Thomas Fleck, managing director of Union Investment Institutional GmbH, is charged with developing relationships with institutional investors and liaising with national and international consultants. “The focus on institutional business helps us to diversify our business pillars in terms both of domestic versus international, and captive versus non-captive,” he explains.

“On the retail side, it’s the same good old story of distribution through captive channels, but 
on the institutional side we want to diversify within Germany and abroad.”

But just as fund managers have made their own opportunities, the German regulator has stepped in with changes designed to boost opportunities for the industry. These changes turned out not to be an exercise in cerebral tinkering, as some had feared, but a 
really radical overhaul of the regulatory environment.

The main thrust of the regulations, which update the Investment Act 2004 and were introduced in January this year, is to recognise a greater number of eligible assets in line with the Ucits III rules across Europe, and to make Germany a better place for domiciling funds.
Angelo Lercara, a partner at Dechert, a German law firm, says: “In Germany we have the phenomenon that the target market is sold funds from abroad, and so there is a disadvantage for domestic providers. A lot of Irish funds are distributed in Germany, for example.”

He also says that the changes make funds more competitive against the zertifikaten product. Zertifikaten are mainly unregulated and can be issued in just a couple of days so the Act has introduced a shorter timeframe for fund approvals.

“This time the regulator really took the market by surprise by doing more than expected,” says Michael Korn, managing director of Allianz Global Investors KAG. “Now Germany is on an even footing. 

You can make the same investments in Germany as you can all across Europe.” 
Nonetheless, there is discussion, if not dispute, about how substantial a practical difference the new law will make. Some suggest that Germany has come a little late to the party; the best cocktails have already been consumed by early birds Luxembourg and Ireland, according to this thesis, and however well turned out the latecomers are, all they’re going to get is some gassy homebrew.

Certainly, Luxembourg and Dublin have established themselves as global standards and there doesn’t seem to be much help for that. In terms of numbers, German-domiciled funds and foreign-domiciled funds sold back into Germany have both been growing, so there doesn’t seem to be a significant shift either way, but when it comes to funds that are targeted internationally many believe Luxembourg or Dublin are likely to remain the domicile of choice.

A new dawn
“If you are a local provider with a local German clientele, then it may now make sense to domicile funds in Germany,” says Klaus Esswein, managing director of SSGA in Germany and Austria, whose own firm markets funds domiciled in Luxembourg, Paris and Dublin to German clients. “But if you have a broader scope and you want to sell in other European or international markets, then you have to look at which place is best accepted by international intermediaries and that is Luxembourg,”

On the other hand, there are areas on the institutional side where, some believe, the regulatory changes herald a new dawn, namely in the increase of eligible assets.

“For a lot of clients it won’t make a difference since they won't engage in this new arena because their investment guidelines prohibit it or because risk aversion means they don't want to enter the alternative space,” says Korn, at AGI. “But for most sophisticated investors – and a lot of German sponsors are becoming sophisticated investors – it will make a huge difference.”

Might this open the German market further to foreign providers? Perhaps a little. Alongside the expanded universe of permissible investments, some cite the new law’s more flexible arrangements regarding the Investmentaktiengesellschaft (Investment AG), a Sicav-like vehicle, as a potential lever. Investment AG can be administered by the promoter itself or by a third party, who then has responsibility for the vehicle.

“It reduces the entry hurdle into the German market for foreigners,” says Dietmar Roessler, a managing director at BNP Paribas Securities Services in Frankfurt. “It’s emerging as a topic. Some Investment AGs are in the pipeline.”

A different market
But many believe the German market was already open and that new legal structures such as the Investment AG will make little difference. “Regulation was not a reason for lack of success by foreign groups; it was more of an excuse,” comments Karl Olbert, a senior consultant at the Frankfurt consultancy [email protected] AG, who formerly worked with Deutsche Asset Management in both London and Frankfurt. Foreign firms that fail to gain a foothold in the German market have often missed the crucial point that Germany is simply anders, or different, he says.

Peter Schwicht, who heads up JP Morgan Asset Management’s (JPMAM) business in Germany, Austria and Switzerland endorses this view. JPMAM has been in the German market since 1989 and has nearly as much under management in Germany as it does in the UK.

“We never had the feeling that regulation was preventing the growth of our business,” says Schwicht. “It’s rather that head offices have to accept that Germany is different from the UK and the US. It’s always taken a while for head offices to accept that there are different ways of looking at the world.”

However, Schwicht, who believes in the ‘local, local, local’ mantra – ie, local decision-making, local client service, and investment in a local infrastructure – does concede that, in the beginning at least, lack of understanding of difference was a two-way street. Initially foreign groups selling in Germany were met with suspicion, though this has changed.

“It’s interesting to note that it’s not an issue any more to be a foreign player,” he says. “Ten years ago we were questioned again and again about whether we were in for the long haul. Now foreign players have been well accepted.”

This is partly the result of a professionalisation of institutional investors, due at least to some extent to the increased involvement of investment consultants, via whom Schwicht says about one-third of JPMAM’s mandates now come compared with around 5% ten years ago. “What matters is product quality as well as a local service model,” says Schwicht.  

Domestic players
The numbers, of course, show a continued bias towards national players. Fleck, of Union Investment, says: “If you look at the statistics, it’s still extremely domestic. We welcome all competition, but the added skill set that foreign asset managers are offering can be extremely limited.”

It’s unsurprising perhaps that investors often still prefer the national players they know and trust. After all, there’s nothing wrong with the national players – another point that some foreign groups may have missed in the past.

“We have very good domestic players, who are becoming more international,” says Schwicht. “They take what they learn from other countries and they bring it back.”

And, as has become abundantly clear in the current crisis, Anglo-Saxon groups don’t possess any magic formula that makes them special.

“If you have enough experience in the market you learn that most peers cook with water,” says Korn. “It’s always hard to find the right alpha. The current crisis affects everyone and there are no natural winners or losers. But if there is a loser it’s the Americans rather than the Europeans.”

Foreign players can and do succeed in Germany, but not through fireworks. They need commitment, patience, a strong local presence and, says Schwicht, “to invest and to invest a large amount of money at the beginning, particularly in regional service support.”

It’s perhaps harder now than in the past for new entrants. Many distributors now have a list in place of fund managers with whom they want to work and they don’t stray too much from that. On the other hand, the size of the opportunity means that there are still openings for those with the right products and the right attitude.

“There are opportunities and there always will be,” says Esswein. “But new entrants certainly need a clear strategy and very good products that are already on platforms or are being rated in other countries. Or they need a big pot for advertising spend.”

With investors fleeing into money market funds and the Deutsche Aktieninstitut (German Equity Institute) reporting that investment in equities by German investors (direct and through funds) is at an all-time low, it might seem like a strange time to talk about the size of the German opportunity. But the truth is the fundamental drivers haven’t changed and the potential offered by the German market is enormous.

Potential in pensions
“Here in Germany we still have a strong manufacturing base compared with other European countries,” says Olbert. “But if you look at pension funding as a percentage of GDP, it’s over 120% in Switzerland and 16% in Germany. “If corporate funds really start to move towards funding, to say nothing of public funds, the potential is huge.”

On top of that, recent changes to withholding tax mean that private banks are moving their clients’ portfolios into funds. Plus there is strong evidence of insurers tending more towards unit-linked products now than in the past. 

Like elsewhere, the credit crunch has bitten deep, but people still need long-term savings and that makes the German market extremely attractive – even if some of the battles regarding a level playing field for fund products in the German pension savings market are still to be won. The BVI, the German fund association, is already lobbying the main political parties on this issue in anticipation of next year’s general election.

“The underlying story has not changed; it’s still pensions and wealth accumulation,” says Schwicht. “The market is parked at the moment either in bank deposits or money market funds. Advisers are waiting for the right moment to advise clients to come back into the market.”

© 2008 funds europe