German institutional investors are entering 2010 with both their investment portfolios and strategies much changed from the pre-crisis status quo. The worldwide decline in equity valuations in 2008 had a dramatic impact on institutional portfolios in Germany, shrinking equity allocations to historically low levels before recovering to some extent in 2009. Although a significant proportion of German institutions plan to increase their still-diminished equity allocations over the next three years, the results of Greenwich Associates’ 2009 German Investment Management Study reveal that a bigger share plans to leave equity allocations unchanged at their present size – a decision that could relegate equities to the status of a niche asset class in Germany for the foreseeable future.
German institutions have lost confidence in external managers. The drop in asset values associated with the global market collapse has greatly reduced the amount of assets allocated by German institutions to external managers. Rather than rebuilding these allotments, many German institutions are moving in the opposite direction. As they look to eliminate risk from their investment portfolios by shifting assets into fixed income and other lower-risk asset classes, many institutions are bringing the management of these assets in-house. This change in philosophy poses a serious challenge to the businesses of both investment managers and consultants competing in Germany.
The new imperative: capital preservation
German institutions have historically ranked among Europe’s most conservative, maintaining large allocations to fixed income and making only relatively small forays into equities, let alone private equity or hedge funds. In the years leading up to the onset of the global financial crisis, however, German institutions joined their peers in Europe and around the world in a move to diversify portfolios by increasing their exposure to equities and international assets.
Institutions worldwide spent much of 2009 trying to assess how these diversification strategies performed relative to other investment approaches during the market downturn, and deciding whether to keep these strategies in place. To date, the results of these strategic reviews have been mixed – in the US, institutions appear to have concluded that their broad diversification strategies are fundamentally sound, and institutions there continue to expand allocations to international equities and alternative assets. Across continental Europe the reaction has been less homogeneous, with some institutions electing to continue with strategies put in place prior to the crisis, and others putting the diversification push on hold in order to take out risk from their portfolios.
In Germany, institutions have moved quickly to make – or at least ratify – fundamental changes to their investment portfolios and strategies. At a most basic level, any past desire to diversify or internationalise German investment portfolios has been overridden by the imperative of capital preservation. To that end, many German institutions in 2009 opted not to rebalance their portfolios following the swings in asset allocation caused by declines in asset valuations. Looking ahead, although approximately 40% of German institutions interviewed in Q2 2009 said they planned to add to their equity allocations over the next three years, a larger 49% said they plan to leave allocations at the current, much-reduced levels.
From 2008 to 2009, the drop in global equity values contributed to a reduction in German institutions’ equity allocations from 12.1% to 6.4%. The 2009 allocation was smaller than institutions’ 8.1% allocations to cash. Meanwhile, fixed income grew to account for 70.7% of German institutional assets in 2009, with European bonds alone comprising more than two-thirds. “In the wake of the worst financial crisis in most investors’ memory, German institutions have retreated to the asset classes they know best – and what they know best are European bonds,” says Greenwich Associates consultant, Tobias Miarka.
A fundamental reassessment of risk
A large share of German institutions said they plan to keep fixed-income levels steady at the current, inflated levels. Even in cases in which German institutions said they were planning to make significant changes to fixed-income allocations, they were divided on the direction of these changes. Although nearly a quarter of institutions said they expect to reduce allocations to active European government bonds in the coming three years, 17% expect to increase them. “Of course, we do not expect German equity allocations to remain at close to 6%,” says Miarka. “However, our research results make clear that German institutions have no plans to reconstitute equity allocations to anything close to levels that existed before the market collapse. There has been a fundamental reassessment of portfolio risk profiles.”
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