Proposal to abolish open-ended funds includes growing institutional vehicles, reports Lauren Parr
Earlier this summer, fund managers and institutional investors would probably have put Germany’s growing spezialfonds sector near the top of their list of future investment opportunities. But that was abruptly thrown into doubt in July when the country’s Federal Finance Ministry unexpectedly published proposals to abolish all open-ended real estate fund structures.
The proposed overhaul of the German investment regime was prompted by a series of crises experienced by the country’s publikumsfonds, or open-ended funds. Hit by investors withdrawing their money, 11 open-ended funds, including some of the largest in the sector, are liquidating and are likely to sell around €25bn of property.
The entire real estate publikumsfonds sector has assets of €61bn and some of its funds continue to operate successfully. But the proposed changes would stop any new open-ended funds being set up.
The proposals do not distinguish between open-ended funds for retail investors and spezialfonds, which are also open-ended, but are for professional investors only (see below).
If they become law it would be a huge blow to the €34bn spezialfonds sector, which managers and investors say works well, and had been attracting institutional capital as a reaction to open-ended funds’ woes.
Fund managers expanding in Germany have targeted spezialfonds particularly in the past few years; LaSalle Investment Management, Cordea Savills and Internos Real Investors all recently set up regulated KAGs (German investment companies) required to run them, joining Aberdeen Asset Management (through the former Degi fund subsidiary); Warburg Henderson; Pramerica; Schroders; and Morgan Stanley.
Funds’ future under negotiation
Talks over the proposals to make all real estate investments closed-ended have started between the Federal Finance Ministry and participants in the German real estate market, including banks, insurance groups, closed-ended fund association VGF, federal fund association BVI and the German Property Federation, the ZIA.
The initial feedback from the ZIA is positive. This month, president Andreas Mattner said: “The politicians take our concerns seriously – the law will not come into effect in its current form.”
Others agree there are still grounds for compromise, including Dirk-Reiner Voss, a partner at law firm Salans: “Spezialfonds’ abolition is unlikely to go through because public protest has been strong. This is collateral damage; the intention is to abolish open-ended funds.”
He points out that the two closed-ended alternatives the finance ministry is advocat-ing, investment limited partnerships and investment stock companies, are not necessarily suitable for institutional investors.
“Spezialfonds will probably survive because they are an important vehicle for investment by insurance companies and pension funds, for whom it’s not really an option to invest through stock corpora-tions,” Voss adds. “So I think we will see spezialfonds continue to exist.”
Others are not so sure. Boris Bergemann, European head of transaction structuring for Henderson, says: “It could be the death of the spezialfonds sector in the long term.”
In the short term they will continue, as the draft changes envisage ‘grandfathering’, ie only applying the rules to future funds. Managers would not be able to issue new funds of this type after the first draft act was passed but could put in place ‘shelf funds’ during the grandfathering period, giving them scope to set up vehicles under the old regime through which they can invest later.
Paul Muno, managing director of Internos’s German business responsible for fund management, points out that Internos’s first spezialfond, a hotel vehicle that raised €75m of equity from four investors at a first closing this summer, “will have preservation of the status quo for the long run”.
Spezialfonds have short shelf life
According to Henderson’s Bergemann: “In the short term, a lot of shelf funds will be issued, but you can’t just issue 100 spezial-fonds and keep them for years to use when you need them. The rules state that they need to be invested within a four-year period.”
He sees a potential consolidation among licensed managers, with the traditionally very strong KAGs remaining the peer group in the market.
Voss agrees: “It is not cheap to run a KAG, which is one reason some managers have decided to no longer pursue KAG activities.”
The recent increase in KAGs has made the market more competitive; German real estate and finance group WGF terminated its plans to launch a range of spezialfonds even though it received KAG approval.
If all open-ended funds were outlawed, it would present a problem for insurance companies, which require not only well-regulated, tax-transparent vehicles, but also a degree of liquidity. For many insurers, and for many pension funds, spezialfonds rather than closed-ended funds have been their favoured investment vehicle.
They also seem unlikely to want to return to direct investing. As Voss points out: “In the past, insurers that had direct investments have said: ‘It’s too complicated for us; we want to have our properties in a spezial-fonds.’ Because of that, a special group of spezialfonds developed so investors could bring in their direct investments.”
If the legislation did go through in its current form, investors would probably have to seek different investment opportunities. But the alternative investing models the government advocates are not suitable for all institutions invested in open-ended funds.
Smaller pension funds, for example, would prefer to invest in spezialfonds alongside other pension funds, rather than in limited partnerships, which offer tax transparency but tend to lock in investors for the long haul.
Investors seeking a liquid alternative to open-ended funds might favour either daily-traded stock corporations (public companies governed by fund-specific rules) or tax-transparent REITs.
“Should open-ended funds be abolished, investors will need another sort of property investment that can be traded, where you can easily sell the shares,” says Voss. “As a result, we could see greater demand for REITs.”
How spezialfonds rode out Germany’s open-ended fund crisis
The 500-page Capital Investment Code (KAGB), issued on 20 July, contains contentious proposals for the abolition of both open-ended publikumsfonds (public mutual funds) and spezialfonds.
The code is Germany’s response to the European Commission’s Alternative Investment Fund Market directive (AIFMD), which it plans to introduce to replace the 2007 Investment Act.
Spezialfonds are aimed at institutional investors only and offer much more limited liquidity than open-ended funds, which have both retail and institutional investors, daily liquidity and net asset value pricing – which led to problems when investors queued to withdraw their money following the financial crisis four years ago.
Designed to grow over the long-term, spezialfonds issue new units as they grow, giving them liquidity. New assets are continually bought and existing units will normally be taken back at any time.
While the KAGs that manage the assets are obliged to take back investors’ units, this obligation is often modified in the special terms of spezialfonds. This is one reason why they were not affected by the crisis that hit Germany’s open-ended funds.
There are many different types of spezialfonds, depending on the needs of the specific investor or investors and the size of the real estate spezialfonds market has grown from €11bn to €34bn in 180 funds over the past 10 years.
KAGs are regulated by the German Federal Financial Supervisory Authority (BaFin) and hold the assets in trust, which means they must hold minimum equity capital to cover any redemption claims.
In place of open-ended funds and spezialfonds, the government advocates two types of existing closed-ended fund models: investment limited partnerships and investment stock companies. These models are not new; but what is new are more strict regulations regarding prospectuses and their content, and accounting principles.
Open-ended funds’ loss may be listed sector’s gain
The European Public Real Estate Association (EPRA) used its annual conference in Berlin this month to argue that the Federal Finance Ministry’s threat to open-ended funds is a big opportunity for German listed real estate companies “to fill this investment vacuum”.
In theory, listed companies can offer institutional and retail investors the same kind of stable, long-term income streams from dividends that open-ended funds offer.
Philip Charls, EPRA’s chief executive, said: “Of course it is only a proposal. It is not law yet, but nevertheless, it’s important for us to get in front of the policymakers and state our case – and particularly state our relevance at the socio-economic level.”
EPRA has already started lobbying alongside German property federation the ZIA, although Ulrich Hoeller, chief executive of DIC Asset and ZIA vice chairman stressed that “the public listed sector is not the enemy of open-ended funds”.
Hoeller said the industry must improve the reputation of the quoted sector by showing its “added value” and stability compared with other stock market sectors. “We have to put public real estate as much in the public’s mind as [in] financial investors’, and provide the highest transparency standards and liquidity assurances.”
He added: “We will be much more in contact with political decision makers to show what EPRA is doing. These days, with strong discussion about open-ended funds, closed-ended funds and spezialfonds, it’s pretty clear that these asset classes are important for the German market. However, it is also clear that the volume of these asset classes is going to be reduced.”