Alternative investors lose locust image
German funds have potential for growth under the new government coalition
Hedge funds based in Germany look set to receive a much-needed shot in the arm. A business-friendly government under Angela Merkel has been elected, demand from investors for absolute return products is rising and European regulation, notably in the form of Ucits III, is opening the market.
It is still early days for the new Christian Democrat-Liberal coalition. Even so, the atmosphere of antagonism created by Franz Müntefering, the Social Democrat who described alternative investors as “locusts”, has evaporated.
Frank Dornseifer, head of legal and policy issues of industry body Bundesverband Alternative Investments, said: “There were many German insurance companies that simply would not choose hedge funds as a result. The negative campaign turned alternatives into a no-go area. We have had good talks with senior members from both parties within the coalition and we expect the new government to be more objective – indeed, to see positive impetus for the industry.”
Despite their negativity, the Social Democrats jointly sponsored laws in 2004 to encourage investment in domestic hedge funds and private equity. The results, however, were disappointing. Between 2004 and 2008, the number of German-based hedge funds stabilised at 40 with €2bn under management, according to Absolut Research. The potential for institutional investment, currently limited to 5% of funds under management, is €60bn ($90bn).
Hedge fund certificates – a structured investment wrapper that allows German investors to invest in domestic and international hedge funds – have been more successful, attracting some €30bn of mainly private investors’ money in 2007, falling to €20bn last year.
The value of alternative investment strategies is underlined by German single hedge fund and fund of funds performance last year. According to data from Absolut Research, both sectors outperformed international peers – the Deutsche Hedge Fund index lost 0.95% last year while the Credit Suisse/Tremont Blue Chip Hedge Fund index fell 26.8%. The German fund of hedge funds lost 12.2% while the HFRI Fund of Funds Composite index fell by 20.7%, according to Absolut Research.
Ulf Becker, partner responsible for alternative investments at asset management company Lupus alpha, said: “We need more time. I would not give up. Many investors have not yet learned to cope with hedge fund strategies, they don’t understand them, don’t know how to model them and the demands of regulation are too great for some.”
Because insurance companies are not allowed to invest more than 5% of funds in alternatives, hedge fund investment is uneconomic for smaller institutions. There is hope that BaFin, the German financial regulator, may raise the limit to 10% in response to demand for absolute return investment.
Domestic fund managers point to German investment laws, which insist on transparency, asset segregation, liquidity and accountability. Henning von Issendorff, co-founder of German-based hedge fund Tungsten Capital Management, said: “All the things we have seen go wrong with hedge funds in recent times are avoided by the German rules.”
Von Issendorff, who established Tungsten Capital Management after many years in the London market, also said BaFin had been “very supportive”.
However, many offshore hedge funds based in London or New York continue to find German compliance, and in particular its tax laws, onerous relative to the money they might hope to attract from German funds of hedge funds.
Much of this investment has either flowed into indirect instruments such as certificates, convertibles, securitised debt or onshore absolute return funds. These are largely run by international banks, which has left domestic hedge fund management trailing as a niche industry.
Dornseifer said: “We need clarity and simplicity and tax equality so that Frankfurt is not at a disadvantage to Zurich, Dublin or London.” He pointed to 100 pages of tax commentary on recent additions to investment law. “This is just too complicated for investors or fund managers to understand.”
While critical of the European Commission’s proposed Alternative Investment Fund Management directive, the BAI sees it as an opportunity to improve German legislation, create simpler, pan-European products such as Ucits III, and boost the German hedge fund sector.
The desire for improved asset protection in the wake of market volatility is also driving German private and institutional money to pursue absolute return strategies, according to market participants.
Germany is embracing products that are compliant with Ucits III, the European directive on undertakings for collective investments in transferable securities, which participants hope will open up the market to domestic and foreign investors. Von Issendorff said: “The next mega-trend is that all hedge funds here will look to be 100% Ucits-compliant.”
Jörg Voigt, managing director at Swedish group SEB’s Master Hedge in Frankfurt, said: “We are trying to make both our existing funds and our new funds comply with Ucits III. Obviously, not all hedge fund strategies are viable. The most illiquid investments such as distressed debt and real estate do not work but long/short equity and futures do. Practically, we see Ucits III as a variant on German legislation.”
Becker said: “Our competition is international. German investors already do look to international managers. That is why international hedge funds are offering Ucits III products to gain access to the German market.”
• Leading German hedge fund providers
Single funds: Master Hedge, DWS, INKA, Lupus alpha
Fund of funds: Deka, HansaInvest, Oppenheim
Foreign funds of funds: AIG Privatbank, Aquila Capital, Pernet von Ballmoos, Sauren
Hedge fund certificates: Deutsche Bank, Commerzbank, Sal Oppenheim, BNP Paribas, UBS, SocGen, JP Morgan, HVB
Source: BAI
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