The German mutual fund market has ended the year on a disappointing low, with the technology and new economy asset classes suffering the most as investors develop severe risk aversion
After several years of growth following the long-lasting global stock market's bull run, the mutual fund market in Germany was not able to maintain its growth pace during the year 2001. Although the industry raised nearly â‚¬5bn via new fund launches the total of mutual fund assets shrank by more than 7% from â‚¬423.7bn at year end 2000 to â‚¬393.5bn at the end of October 2001 according to BVI, the German mutual funds association.
Certainly the stock markets have been the main contributors to this development. At the end of October 2001, assets in equity funds were down a dramatic 34.8% year on year. The trend of previous years to shift assets from debt to equity finally ended in 2001, as investors developed a strong risk aversion due to experiencing heavy book losses on basically all equity fund investments made in 2000.
Among mutual funds, the asset classes suffering most from industry wide redemption included funds focusing on new economy and technology stocks, emerging markets stocks but also high yield bonds. Those asset classes are more out of favour due to being perceived as risky and linked to a US economy in recession. Investors currently are not comfortable with turnaround stories. Instead they are looking for protected and/or low risk income products. This trend should continue until a substantial market recovery develops.
The German story
This behaviour of German investors is not hard to explain. The shift of money from equity funds to money market funds or even back to savings accounts just demonstrates how fragile the interest in equity investments generated during the boom years was.
In the past, savings accounts have been the stronghold of German retail banks, mainly from the 1960s to 1980s. A strong desire for safety has always been a driver of German investors' behaviour. This is also underpinned by their large exposure to insurance policies. It was as late as the 1990s when German investors realised that there must be more than the 2.5% interest on savings accounts or 6%-7% yields on life insurance policies.
During the mid-90s, the huge marketing effort in the context of the Deutsche Telekom IPO, the previously state-owned telecom operation, hammered home that in the long run, stock markets return an average of approximately 10% per annum. The following years seemed to prove this theory and, even better, driven by liquidity the stock markets returned in excess of 30% per annum. All the worries about safety and retirement pensions faded. Investors just had to pick the right investment fund and could earn a fortune in a very short time.
The advent of the 'Neuer Markt' promoting growth stocks and the internet seemed to mark a new era perceived as prosperous and unprecedented. Investors demanded more fancy investment products and the German fund industry was only too willing to provide those products. New product launches surged, and with fee rates of 5% front-end load and 1%-1.5% management fee for equity funds it was extremely profitable for distributors and fund providers. The products became more and more specific, abandoning the original idea of risk diversification. One example of this unusual product development is a mutual fund called B2B.com, which focuses just on one specific sector within the internet industry.
Another example of the hype is a single fund called Nordasia.com. During the first three months of 2000, German private investors put more than â‚¬2bn in this fund, investing purely in internet stocks in Asia. This coincided with the peak of the internet bubble and during the following 12 months the fund's NAV went down sharply and investors lost more than 80% of their initial investment. Having experienced heavy losses, it is no wonder investors became risk averse when the bear market continued for more than a year. Although it may now be the best time to invest in equity funds, investors tend to avoid this asset class. The question is where do investors get advice from and do they really get the best advice. So, let's have a look at the distribution side of the business.
In contrast to the UK, where IFAs have the largest market share, the distribution of mutual funds in Germany is dominated by a few big retail banks, such as Deutsche Bank, HypoVereinsbank (HVB), Dresdner Bank, Commerzbank and the large savings bank organisations Sparkassen and Raiffeisen/Volksbanken. Their market share is within the range of 70% to 80%, whereas the IFA business is underdeveloped. Over the past few years those big players have maintained their own asset management operations either in-house, via co-operations, or through outsourced advisors. The result was that clients of organisations such as Deutsche Bank were offered DWS (Deutsche Bank) funds, while Dresdner Bank clients were offered DIT (Dresdner Bank) funds only. As clients tended not to have accounts with many banks they had to buy the respective in-house products and had only a limited choice.
For German banks this meant limited competition and a high degree of protection of their existing client base. As a consequence margins and profitability of the business were high. The environment changed when shrinking margins in other business areas resulted in a consolidation in the sector, accompanied by cost reductions and an increasing appetite for grabbing market share from competitors.
open architecture model
This led to the introduction of 'open architecture' structures in Germany, first established by Citigroup and HVB in 2000. Under open architecture structures German banks entered into distribution agreements with a number of investment product suppliers and as a result they offered competitor funds on their distribution platform alongside their in-house products.
The impact on the market was visible in 2001, when other players followed and also implemented open architecture structures like Deutsche Bank, the undisputed leader in the German market. Deutsche Bank apply their model worldwide instead of limiting it to Germany. How successful have these open architecture structures been? There is clearly a trend that clients are attracted only to a few funds of the large number of funds on offer. One key factor when being considered for inclusion on recommendation lists and attracting clients is performance; hence it is necessary to be among the top ten ranking funds in the relevant peer group. In nine out of 10 cases investors picked well known brands. Therefore, the main beneficiaries of open architecture in Germany were Fidelity, DWS and other well-known brands. These companies spend considerable amounts of their budget on advertising and marketing.
The Fidelity example is a clear indication that it is not a disadvantage to be a foreign asset manager. Especially as the Anglo-Saxon investment approach is highly regarded among German investors. There is a huge opportunity for UK and US asset managers to get their message to the investors. To be successful in the German market requires good service quality as well as good performance. The German authorities are equally demanding ' all asset managers registering their funds in Germany must remember that if they wish to achieve and maintain the distribution permission from BAKred, the German regulator, a high degree of accuracy is required.
The biggest challenge for asset managers operating Europe-wide is to adjust their product offer and service quality to local market requirements. Currently F&C Management, one of the most traditional UK asset managers, is translating its experience in servicing the German market for more than 10 years into building a truly pan-European asset manager.
Although the European market seems to act as one, in reality, a common approach to that market proves to be difficult. Regulations and especially people's needs and expectations differ significantly. Therefore tolerance, flexibility and sensitivity are the main characteristics required from senior management and staff throughout the organisation in order to secure a share of the growing and more open European market.
Germany was not able to maintain its growth pace during the year 2001
The ˜open architecture' structure has impacted the market this year with German banks offering competitor funds alongside their own in-house products.
Although the European market seems to act as one, in reality, a common approach to that market proves to be difficult
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