Wanted: shelf space in Germany

Germany is undoubtedly the most important of Europe’s numerous fund markets. It may not be the largest – both France and Italy are a step ahead of Germany on a straight analysis of assets – but it has a sizeable chunk of the market, 13.2 per cent. (See Chart 1.)

More important, though, is the fact that it has by far the largest number of asset managers and funds pitching for business there. Since the early days of cross-border Ucits funds, Germany has seemed to hold out more shelf space potential than any other market and, in consequence, its 39m or so households now have a choice of over 5300 funds with more than half (60 per cent) from foreign groups.

By contrast, the US market is nearly three times larger by number of households (105m) but has an offering of just 8000 funds. Chart 2 illustrates the extent of foreign interest in Germany compared with other European markets. This is a game that’s been played for a decade or more now, so what’s the reason?

The reason can be found in the profound transformation of the market over the last 10 years. It has evolved from being dedicated to plain vanilla bond products to one offering the most diverse range of investment options. The recent expansion of the investment laws to encompass hedge funds is just the latest installment of this changing market. The growing appetite for equities was a significant attraction to early market entrants and at its peak in 2000, equities accounted for more than half German fund assets. Even now, after the ravages of the bear market, equities retain the largest slice of assets at 32 per cent.

CRIPPLING EFFECT

But the recent bear years have had a crippling effect on the industry. In 2001 the true impact of the crash was muted by the huge interest in funds of funds, which was a godsend for foreign groups who were able to maintain some sales volumes through this new breed of fund buyer. German groups produced sales volumes of €36bn, a long way off their high point. But the German and UK markets were the only ones to maintain positive momentum in every month of the year – even in the immediate aftermath of 9/11.

In 2002, the markets fell steeply and sales volumes dropped even further, recording €26.5bn. Two thousand and three was the year of recovery but sales volumes failed to pick up and although they beat the 2002 low (€28.3bn), the increase was considerably lower than expected.

The German stock market was the strongest of the European bourses – more than any other, it experienced the Baghdad bounce, but as stock markets started to rise, net flows into retail fell month by month. And the situation was particularly acute for German equity funds.

DAX EFFECTS

Chart 3 depicts the extreme buying and selling behaviour in response to stock market performance. A small surge in the DAX more often than not led to a huge surge in equity flows. Equally, a small setback would lead to rapid redemptions from the sector. Sales in 2004 are a case in point – German stock funds performed well in January in response to last year’s rises in the DAX, but there was a hasty retreat as the DAX suffered a downturn in February and March.

So far this year equities have posted a net redemption figure of €850m and surprisingly, in this environment of potential interest rate rises, the bond culture has returned and fixed-income funds took €7.3bn of net subscriptions in the first four months of the year.

Essentially, the German market has very few mainstream investors at the moment and the bulk of sales come from the professional buyers. It is these buyers who have been enhancing their portfolios with large asset allocation shifts and have made the German market considerably more volatile than usual.

So, in this new environment, is there any room on the shelf for the 3000 or so foreign products on offer in the market? Basically, yes. Foreign groups have done rather well. In 2003, they accounted for 9 per cent of all net sales but in terms of equity sales, their share was considerably higher at 36 per cent (source: FERI FMI).

But the market remains highly competitive and professional fund buyers rule the roost, so how does a foreign group differentiate itself from its competitors? Clearly, performance is critical for any group that is looking to attract a third-party distributor but, depending on the type of distribution channel targeted, other factors weigh in. Typically, these include support and service issues such as:

• commitment to advertising and promotion support
• fees and retrocessions
• positive brand identity – recognition factor
• breadth of fund range.

The relative weighting of these factors will depend on the type of distributor.

CHANGING DISTRIBUTION MIX

The general perception of distribution in Germany, and of course, across most of Continental Europe, is that the banks dominate. Of course this is the case as far as domestic product sales are concerned. Open architecture is present in Germany but two of the largest houses (Deka and Union) operate on an entirely proprietary basis and this affects the overall picture of distribution.

The best course of action for foreign groups is to identify where they are in the general sales mix. Chart 4 illustrates our estimates of assets by distribution channel for foreign groups and how market share has changed. In percentage terms private banks, discretionary portfolio managers and IFA pools were the best options for attracting sales in 2000 – the heady days when mainstream investors were buying.

Lack of reliable data makes it difficult to estimate the size of the pie but we put it in the region of around €50bn today. However, over the last five years, the distribution mix has changed and ‘bank-guided architecture’ platforms are gaining significance in the mix, whereas traditional IFA business, undoubtedly harmed by the bear market – has lost substantial market share.

Finding business in this new environment will increasingly depend on the type of business. A large international player who can offer a full range of specialist and generalist funds can happily pitch to all these distribution segments. For the bank platforms, (including the insurance sector), bandwidth and brand really count – client-facing sales people want products with which their clients feel comfortable.

Smaller groups however, will need to focus on their specialist strengths and this means a much bigger focus on performance. One of the reasons foreign groups have enjoyed particular success in recent months is down to the enthusiasm for Asian and Japan investment and groups with funds in this sector have been able to build business on the back of this enthusiasm, particularly with private banks and higher net worth advisers.

As for funds of funds, they were extremely important in 2001, just after the crash, and for many foreign groups, they helped cushion the worst aspects of the market decline. However, flows from many of these asset allocators have tended to be rather fast and loose. Right now the opportunity seems to be rather marginal. The in-house funds have had the best of the sales volumes over the last year in the sense that they are positive rather than negative. These are the really big funds and they probably account for a lot of the volatility we are seeing in the market. The third-party is trending upwards but the volumes, even when positive, are extremely small.

To conclude – Germany remains an extremely important market and its importance can only grow as the pension business develops. However, in order to maximise, foreign managers need to understand their strengths and pitch them in the right quarters.

Bella Caridade-Ferreira, editor and research manager, FERI Fund Market Information Ltd