Thursday, October 7, 2010 Stamford, CT USA — Investment returns are taking a back-seat to risk management and stability concerns among German institutions, which appear to be sitting back and waiting for clues about broad market direction before making any radical changes to their current, conservative investment approaches.
According to the results of Greenwich Associates' 2010 German Investment Management Study, German institutions reported solid growth of 9.2% in assets under management from 2009 to 2010. (AUM totals are based on the results of interviews conducted with a matched sample of German institutions between March and May of both years.) This growth — which reversed but has not yet entirely made up the decline in AUM experienced during the down markets from 2008 to 2009 — was based largely on the steady appreciation of asset values. However, the shifting composition of institutional portfolios reveals the extent to which German institutions are emphasizing de-risking over alpha generation: Over a period of historically strong performance in the DAX Index, institutional equity allocations in Germany increased by less than 1%.
"For German institutions, risk management imperatives are trumping any desires to seek out performance," observes Greenwich Associates consultant Tobias Miarka. The 227 large German institutions participating in Greenwich Associates' 2010 Investment Management Study clearly communicated that safety, stability and conservatism were their top priorities this year. Asked to name the issues that "keep them up at night," the institutions gave prominent mention to "asset/liability mismatches," the implications of new Solvency II rules, "risk reporting" and the questions of how to meet "the company's needs for safe investments" and where to find "crisis-proof investments." The question of how to generate higher levels of returns or alpha within their portfolios merited much less mention.
German institutions did take steps to address the concentration of portfolio assets in fixed income generally and in European bonds specifically. Fixed-income allocations declined to 66.3% of total institutional assets in 2010 from 68.7% in 2009. Rather than shifting these assets to equities, however, institutions moved many of them to real estate. Allocations to real estate increased to 6.7% of total institutional assets in Germany in 2010 from 5.1% in 2009 — a move that reflected the desire of many institutions to take down risk levels, add steady income streams to their portfolios, and reduce volatility — at least from an accounting point of view.
Within fixed-income portfolios, allocations to European bonds declined to 60.2% of total institutional assets in 2010 from 65.0% in 2009, reflecting both active diversification efforts on the part of German institutions and the effects of the burgeoning Greek crisis on the Euro and European markets overall. Allocations to international bonds increased to 6.1% of total assets from 3.7%. After peaking in 2008 at 14.2% of assets, overall equity allocations increased to 7.9% of total assets in 2010 from 7.6% in 2009. Within equities portfolios, allocations to active European equities increased slightly, allocations to passive European equities decreased slightly and allocation to international equities were flat to slightly higher.
"Of course, there are wide variations in allocation among the various types of institutions investing in Germany," notes Tobias Miarka. "Equities make up a third of total assets in the portfolios of corporate treasury funds, which allocate only 52.9% of assets to fixed income. Reflecting their low risk budgets, insurance companies and savings banks remain heavily invested in European bonds and allocate less than 5% of total assets to equities."
Expected Rates of Return
German pensions have reduced their expected rates of return on all asset classes except hedge funds. Expected annual rates of return over the next five years decreased to 3.9% in 2010 from 4.2% in fixed income and to 6.2% from 6.6% in European equities. Expected returns on hedge funds increased to 7.1% from 6.6%.
Continued Skepticism Toward External Managers
Although the total amount of assets allocated by German institutions to external investment managers increased from 2009 to 2010 in step with the broader recovery in asset valuations, the share of institutions employing external managers in key asset classes declined. The share of German institutions reporting that they employ an external manager for European equities declined to 51% in 2010 from 56% in 2009 — both down from a high of 64% in 2008. These shares also declined for U.S. equities, Japanese equities, Asian stocks and other equity products. The only increases in usage came in global equities (to 25% in 2010 from 22% in 2009) and emerging market equities (to 14% from 11%), but even these shares remain far below 2008 levels.
"The falloff in the use of external managers for European bonds was even more dramatic," says Tobias Miarka. "In 2009, approximately two-thirds of German institutions used an external manager for active European bonds; in 2010 that share fell to 53%."