Calculating the value of partnerships

Among Europe’s mutual funds markets, there is one which currently stands out more than most. Liberalisation of investment instruments, taxation changes, the evolution of a more flexible regulatory environment, introduction of hedge fund products, and above all, a commitment by major banks to sell products manufactured by other institutions, have made Germany uniquely attractive to both foreign and domestic asset management groups.

The distribution revolution in the German mutual funds market was pioneered by Commerzbank at the beginning of 2001, when it started to sell a product composed of underlying external funds. Later that year, bank branch staff began to recommend the first non-Commerzbank fund to customers. There were no surprises here – the first on the buy-list was Europe’s largest – and most expensive, thereby able to pay bigger commissions – product, Fidelity’s European Growth Fund.

Further funds of external funds were launched in 2003 and later that year 20 external funds were being marketed to Commerzbank branch customers. The menu included products manufactured by Credit Suisse, DWS, Fidelity, Invesco, Merrill Lynch, Morgan Stanley, Nordea, UBS and Threadneedle. At the same time, the bank also tied up an agreement with SEI Investments, to sell the US group’s multi-manager solutions.

The decision at Commerzbank was a controversial one, with reverberations through the group’s asset management division in particular, which can still be heard today.

Bitter pill

Offering funds of external groups was bad enough, but putting products of deadly rival DWS on the shelves was at the time termed as “corporate suicide” by Commerzbank dissenters. There was also an insinuation that in-house products were not as high quality as what was available elsewhere.

Paul Burik, managing director of the Commerzbank Asset Management Group takes up the story. “We don’t reject the bank’s idea that its bold claim to offer open architecture will improve the quality of our product in the longer term,” says Mr Burik.

“What is more controversial is the extent to which the bank will benefit from opening up to the competition. The rest of the market is not opening up as quickly as Commerzbank. So the danger is that we as a division might not be able to sell as much volume to other banks as competitors can to Commerzbank, even as we upgrade our product offerings. That puts considerable pressure on our division.”

Similar political problems were inevitably caused at Deutsche Bank, which began to sell the funds of eight strategic partners in June 2003. Deutsche did not include the Commerzbank funds on its list, but this did not stop Axel Benkner, chief executive of Deutsche’s in-house funds manufacturing arm, DWS, initially claiming he would now be concentrating on distributing funds through independent financial advisers (IFAs), rather than bank branches.

These teething troubles at Deutsche seem to have been overcome, and bank insiders say that DWS funds are clearly their best sellers. The question for other strategic partners is has the value of the partnership really been worthwhile? Have the marketing costs associated with being a strategic partner been covered by the inflow of new funds?

Axa, which was not on the list, still claims to have garnered E100m in funds sold through Deutsche Bank branches. “In reality, we are getting more money than some preferred providers. It really doesn’t help being called ‘preferred’,” says Christian Wrede, CEO of Axa Investment Managers in Frankfurt.

“There is a certain polarisation in the market, with the big banks moving from open to guided architecture, as their distribution channels cannot deal with 500 funds,” adds Mr Wrede.

“But it’s an illusion that there is a global gate-keeper, sitting in any bank saying: ‘Now that we have put you on our list, every single one of our bankers in Europe will automatically sell your funds and the floodgates will open. Unfortunately, it does not happen that way.”

Lips are sealed

Managers on these lists, although reluctant to divulge how much they have pulled in from clients, are loathe to agree that this experiment in “guided” architecture – where advisers guide clients through a limited menu of funds – has failed.

It is still too early to tell whether the deals have been a success, says Mark Luning, managing director of ACM International, the European subsidiary of Alliance Capital, whose funds are on Deutsche’s list.

“Deutsche Bank is doing ground-breaking things in Germany and Italy, things which don’t develop over a year or so and we are happy to be in its programme early. The activities in its branch systems will mature over time, and then we will see.”

Goldman Sachs Asset Management, despite not being on the list, is still up-beat in general about German distribution and sub-advisory opportunities. GSAM has made substantial investments in its German operation, and these have already yielded $10bn (e7.7bn) in assets over five years, making Goldman the largest foreign player in Frankfurt.

“We will continue to invest in the proven dynamism of the German market,” says Suzanne Donohoe, CEO of GSAM’s European business.

“German clients don’t think so much about the return spectrum, but about volatility and yield. There is a much greater appetite here for currency, hedge funds and global tactical asset allocation.”

GSAM has been winning business not just from banks that want to put external products on their own distribution platforms, but also from those banks and insurance companies selling products which delegate the asset management to an external sub-adviser.

There is a clear consensus that German insurance companies have not managed their assets well. “They had a too high equity allocation of 20 per cent,” believes Mr Wrede at Axa. He also claims many insurers made mis-allocations to private equity and hedge funds.

But there are also deeper problems which the insurers must face, says Stephan Romer, head of German business development for SEI in Frankfurt.

“It is a very difficult time for insurance companies right now in Germany in many ways,” says Mr Romer. “There are major tax changes for life insurance policies, so there is a risk that many may be redeemed next year.”

Weakening balance-sheets have added to the uncertainty, and asset managers must be highly sensitive to the needs of this sector, he believes. But other market players are viewing these under-achievements with a sense of schadenfreude.

“The insurance companies are the big villains in this market,” said one insider at a major German funds house.

“As well as poor performance, there are no details of the huge charges being levied on investors. There is very little transparency.”

Competitive clashes

If this sounds familiar, it probably is. The view of insurance companies from the fund houses echoes their opinion of investment banks, currently the sworn enemy of Germany’s fund management industry.

“As an industry, we are in a strong competitive situation with investment bankers,” says Rudolf Siebel, managing director of the BVI, the German funds association. “There are 46,000 structured products in Germany alone, ranging from index replication bonds to highly complicated knock-out options. In Germany they can be launched off the shelf in just one day. This gives huge flexibility to the investment banks and has led to the loss of huge inflows to the funds industry, especially during falling markets.”

The situation is a highly politicised one in the management suites of the two major distribution players, Deutsche and Commerzbank, with similarities to the parallel open architecture debate.

At Deutshce, reveals Klaus Martini, chief investment officer of the bank’s Private Wealth Management division, when there is a case for investment, clients must get into the market quickly. Because certificates, structured by the investment banking divisions, are available immediately, private clients can be steered into them while the markets are still steaming up. But by the time a fund has been launched by the in-house subsidiary, it is often too late to buy it.

This is a problem for the fund marketing machines, which cannot gear up quickly enough, and may lose revenues as a result.

“Certificate products and more traditional mutual fund products are definitely in competition with each other,” says Commerzbank’s Mr Burik. “A securities division is creating certificate products and distribution of these products is often preventing inflows into asset management in the same organisation.”

This is a real issue at Commerzbank, says Mr Burik, where adoption of a very broad form of open architecture, which substitutes third-party funds for in-house products, also increases the attractiveness of certificates.

“Some of this attractiveness is the question of timing. Hedge fund certificates were available first, in a favourable market, says Mr Burik,” explaining in part why Germany’s adoption of retail hedge funds this year has not been as successful as hoped.

“Real fund products were only launched after huge volumes of certificates had been placed, already meeting customer needs. The certificates also have protection qualities. In a highly uncertain environment, people may be far more confortable with this.”

Benkner: initially claimed Deutsche would focus on IFA distribution