MiFID II is said to be squeezing the German funds industry and hindering its global competitiveness – but as Mark Latham finds, an ebullient mood persists in a country where more institutions are investing in funds.
After record inflows into German funds in recent years, a market wobble in the final quarter of 2018 was followed by a post-crisis record low level of inflows in the first quarter of this year. This €24 billion total was well down on the €38 billion in January to March last year and from the €40 billion of 2018’s fourth quarter.
Net inflows for the whole of 2018 were €117 billion – down from the record years of 2015 (€193 billion) and 2017 (€160 billion), but higher than 2016’s inflows of $103 billion. Despite this drop, total assets under management in German open-ended investment funds and discretionary mandates still reached a record high of €3.1 trillion in March, up 6% since December 31.
Harald Rieger, head of distribution for Germany and Austria at DWS, points out that for four years in a row, from the record year of 2015, the German retail market had seen major inflows into multi-asset funds (€14 billion in 2015, €2.3 billion in 2016, €10.7 billion in 2016 and €5.4 billion in 2018).
However, since the market drop in the last quarter of 2018, inflows into multi-asset funds in the German retail space have fallen off.
The German market has also seen significant outflows from fixed income funds in the first quarter of 2019 (although asset allocators continue to invest). These outflows amount to more than €3 billion, according to the German national funds association, BVI, “and we see that partly in our client behaviour as well”, says Rieger.
Taking up the slack to some extent, DWS’s total return multi-asset funds as well as open-ended real estate funds have been doing well in 2019, with inflows of more than €2 billion so far. This follows a strong 2018, especially for its open-ended real estate funds, which enjoyed net inflows of €1.2 billion.
The same goes for exchange-traded funds (ETFs), with significant inflows both in 2018 (€8 billion) and 2019 (€2 billion year-to-date).
“What I see at the moment is a kind of barbell strategy in client behaviour: investors who were disappointed by the performance of multi-asset in 2018 are being a bit more cautious in 2019 because of the late cycle that we are currently in,” says Rieger.
“I actually think that people realise that the cycle has been lasting for quite some time, so a lot of people acknowledge that they need equity exposure, but on the conservative side, fixed income is hardly an option any more and investors are shifting into open real estate funds as an alternative. Interest rates are so low, spreads have come down significantly again, so where do investors go?”
DWS is currently the largest asset manager in the German retail market, with total assets under management (AuM) of €704 billion, of which AuM in Germany amounts to €305 billion, institutional AuM is €394 billion and retail is €311 billion. Globally the firm has AuM of €188 billion in the Americas, €175 billion in Emea excluding Germany and €37 billion in Asia-Pacific.
“Our current strategy is to protect and grow our position in the German domestic retail market and for the institutional market, we want to grow further,” says Rieger. “We are not where we want to be at the moment on the institutional side and there is clearly much stronger growth potential there.”
Another marked trend in the German market in recent years, he notes, has been a growing interest among retail investors in funds that follow the UN Sustainable Development Goals (SDGs). “ESG investing is often perceived by retail investors as avoiding certain forbidden companies because of something bad, but with SDG, you turn the picture around and positively invest into equities which support the UN code,” he says.
In April it emerged that Deutsche Bank and UBS had entered into serious talks on merging their asset management units in a deal that would have created a €1.4 trillion business. But last month, it was reported that talks over the proposed merger – which would have created an entity similar in size to Europe’s largest asset manager, Amundi – had stalled because of disagreement over who would control the combined entity, together with valuations.
Deutsche suffered another setback in April when it abandoned merger talks with Commerzbank, with both sides saying that the risks and costs were too great. Had it been successful, the deal would have created the eurozone’s second-largest bank.
However, speculation around the proposed mergers had no impact on investor behaviour, according to Rieger: “There was hardly any impact on fund flows driven by those merger talks: we did not see anything.”
Over at BVI, the main worry for chief executive Thomas Richter in recent years has been what he calls “over-regulation and in some cases, bad regulation”.
He is pleased that, bowing to pressure, EU legislators in February delayed the full implementation of the controversial Priips (Packaged Retail Investment and Insurance-Based Products) regulation for a further two years, from 2020 to 2022.
But he says the second Markets in Financial Instruments Directive (MiFID II) “turned out to be an awful piece of over-regulation”. He hopes, however, that some of its worst features will eventually be improved.
Richter cites a recent study by Bochum University that concludes MiFID II has led to a “disastrous” 27% drop in investment in securities since its implementation in January 2018. “There are now fewer and fewer investors who are willing to buy securities and invest in capital markets because of MiFID II,” he says.
He believes over-regulation, much of it imposed as a response to the global financial crisis, has reached the stage where “it is impeding us from developing our strengths on a global scale”.
He adds: “We are all working in an open market and on a global scale and we have very strong competitors from the US. Unfortunately, we are not able to demonstrate our strengths and invest in technology because we are implementing MiFID II, which has cost us a huge amount.
“The resources that are eaten up by MiFID II from a personnel, financial and time perspective are just too high.”
So, has anything good come out of MiFID II? “Of course, within 20,000 pages of regulation there is bound to be some good in it, but the bottom line is that there is more bad than good,” he says.
“If you look at the cost and effort that went into implementation, the collateral damage on the retail investor side definitely outweighs the benefits that there undoubtedly are.”
Despite a wobbly first quarter of 2019 – “the weakest quarter ever”, according to Richter – the big picture for the German funds industry is that assets under management have doubled over the past decade, to €3.1 trillion euros, and that growth is “ongoing”.
The main factors that dominate the industry in Germany are the continuing low interest rate environment and the “ever-increasing demand from institutional investors who invest more and more of their assets in funds, rather than managing the assets by themselves on their own”.
Richter bats away a question on whether Germany, as some economists have suggested, is on the verge of recession. “The economic outlook might be a bit more bleak than it was a year ago and the German government has cut their forecast a little bit, but I don’t expect a significant impact on the demand for investment funds,” he says. “This is not a crucial factor from my perspective.”
On the issue of corporate governance, which has been at the centre of political debate in Germany since the Volkswagen emissions scandal of 2015, he points out that BVI promoted high standards for “many years” before the scandal erupted by – for example – issuing guidelines to its members on voting at annual general meetings. “We are working on these guidelines on a continuous basis and they are being continuously developed and adapted to the most recent developments.”
Relatively few national funds associations have issued guidelines to members on corporate governance, he adds. “The ESG discussion in Germany is very much focused on the E: climate and carbon and all these things. However, the S and the G are somewhat neglected.”
The issue of corporate governance has also been to the fore at Frankfurt-based Union Investment, Germany’s third-largest asset manager with AuM of €338 billion. Last month, Union revealed that none of the firms in the Stoxx Europe 50 index met minimum criteria for director pay, diversity, supervisory board independence and transparency.
The survey, compiled by Union and the German proxy adviser Ivox Glass Lewis, also revealed a strong regional divide across Europe, with companies in the north (particularly Germany, the Netherlands and the UK) performing markedly better than their neighbours further south (especially France, Italy and Spain).
Alexander Schindler, a member of Union’s executive board, believes that the issue of corporate governance is rising up asset managers’ agenda. At the annual general meeting of German chemicals behemoth Bayer, for instance, shareholders expressed their anger over the firm’s stock price slump, precipitated by rising concern over litigation risks following Bayer’s $63 billion (€56 billion) takeover of US agro-chemical giant Monsanto.
For the first time in Bayer’s history, shareholders at the meeting in late April (including Bayer’s largest shareholder, the US fund manager BlackRock) voted down ratifying the executive board’s business conduct in 2018 and handed down a vote of no confidence in the firm’s chief executive.
“It is clear that there is a growing group of shareholders, both in the German market but also internationally, which is raising its voice on corporate governance issues,” says Schindler.
After a rocky last quarter of 2018, business this year has so far been good, he adds, with more than €7 billion of net inflows in the first four-and-a-half months of 2019. Roughly two-thirds of the inflows have been from institutional investors and the remaining third from the retail side.
Asked what he expects to be the major themes for the investment industry in the years to come, Schindler cites the search for yield, given the likelihood of a continuing and long-lasting low interest rate environment.
He also says that environmental, social and governance (ESG) investment and “the search for alternative investments in private markets rather than listed markets” will also dominate the funds industry in the medium to long term.
Brexit, he believes, will have only a “very limited impact” on his company. “Our exposure to the UK market from a business perspective is still very limited. It will have an impact on our investment on equities and fixed income and so on.
“But the assessment of the political uncertainty between Europe and the UK has already been assessed much earlier and incorporated into our investment strategies and allocations. Whatever the outcome, there is going to be additional impact on investment positioning.
“I am sure that the financial supervisory authorities, the FCA [UK Financial Conduct Authority], Esma [European Securities and Markets Authority] or the European Banking Authority and others will do their utmost to preserve the stability of the financial markets.
“On the continent, everybody is aware of the importance of the UK financial industry for the financing of European growth. Likewise for the UK, European markets are important for the distribution of financial services, be it asset management products or other financial products. At the end of the day, the UK financial industry will have to comply with all European regulations with regard to finance and will also have to comply with its own as well.”
Volker Samonigg, head of business development for Germany at Barings, says that – as the low interest rate environment continues and the cost of hedging US dollar assets back to the euro remains high – his firm is seeing continued demand in Germany for higher-yielding investments and for European investments.
“Another trend we have seen is investors reviewing their emerging market debt allocations and some reallocations of investment happening as a clear dispersion of quality managers has become visible in the sector.”
Looking ahead, he expects growth in the real asset and private markets business. “Investors seeking returns are likely to continue to look for higher-yielding asset classes diversifying in illiquid assets in order to meet their required returns,” he says. “We expect real estate private equity and debt to be sectors that benefit from this.”
Another company that expects continued growth in the real assets sector is the €20 billion German investment manager KGAL Capital, which focuses exclusively on real estate, renewables and the aviation finance sectors. Florian Martin, spokesman for its management board, says: “What we’re seeing is investors taking a broader-based approach to real assets and exploring opportunities in addition to real estate.
“Increasingly, they are seeing real assets as part of a wider investment strategy – primarily due to the benefits of diversification and contractual income. This is a trend we expect to continue.”
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