Risk, control and manager service levels top the agenda in Germany, discovers Martin Hurst.

The downturn has focused the mind on risk, scope to take risk and regulation.  And the issue is poignant for Germany's investor community, especially as the draft EU AIFM directive proposes to limit the extent to which investors can take risk.

"Risk is top of the agenda," says one investor who believes "smaller users of the system must be protected but institutions must be given room to take risk because they know what they're doing."

For this investor the subject of pension fund governance is key. In Germany there are a significant number of small pension funds. "Governance is expensive," he says. "Many pension funds are so small they don't have the resource to put appropriate governance structures in place."

So should there be consolidation? "Yes," he says, "but in Germany they all want to remain independent."

He stresses the key question: "How large should a pension fund be, to be able to afford a minimum governance structure?"

German investors, like their counterparts elsewhere in Europe, are moving towards club deals. "There is a clear trend," remarks one pension fund manager. "They are more homogeneous, they offer greater control, faster execution and the ability to invest more precisely in relation to the mandate. They respond to the key investor needs for greater control, liquidity and speed."

He stresses the importance of size in the world of investor clubs. "With a large group of investors it will always be difficult to get agreement from everyone," he notes. "More discussion is required to ensure that the strategist keeps to the agreed strategy."

The concern is shared by another investor who adds: "Investor clubs have become too big. We may work with two other investors in a fund."

Service issues are also high on the agenda, and fees are once again a point of discussion.

Does the economic climate influence the fee structure? Some argue that many fee structures were set up without considering that the market may also fall as well as rise and that new structures may be required to address the new market realities - and in some cases keep managers afloat. But one investor asks: "Why should we revisit fee structures because the market is in a downturn? Managers should build reserves in the good times so that they can ride out the bad times, rather than paying out excessive bonuses." 

This view is echoed elsewhere. Another pension fund manager says: "In the boom too much was earned and most managers made too little provision for leaner times. Managers became used to high salaries and now that the bonuses are gone they are demotivated. But they need to get used to this new climate. Pay in investment management and investment banking must be more realistic."

With financial engineering out of favour, all talk is of ‘back-to-basics' asset management, with more focus at asset level. The ability to do this well will prove critical in determining who retains business and who does not. But one investor notes: "Managers have all promised that they can manage property but in reality not all of them can do it. Many of them are good at talking but not at doing. The rental contract may be wonderful but what about the building?"

Another investor comments: "Managers are shedding staff so they don't have the resource to manage the assets. Class ‘A' buildings need to be sharpened up. Often we need to go into the market and sell bad buildings because the managers are not proactive. Property management is not active enough to justify the high fees being charged. And investment managers communicate with and incentivise their property managers too little."

Like many of his counterparts he stresses that reporting and feedback from managers is becoming increasingly important. "Investors want to be told the truth as soon as possible so they can discuss necessary action."

In these challenging times the consolidation among real estate investment managers is underway. "Managers who belong to a bank - RREEF, Credit Suisse, ING Real Estate, Merryl Lynch might be sold off as the banks choose to focus on their troubled core business of banking and sell off their investment management business," suggests one investor.

Interest in new forms of investment has increased as the downturn has highlighted pricing differences, notably between the public and private markets. "We are looking at what real estate instruments there are and how they behave," one investor comments. "For example are real estate equities an indicator of future trends in the private / direct market?"

He adds: "We can tackle market volatility by using a mix of listed and unlisted. This offers arbitrage opportunities and the ability to manage the portfolio tactically which is becoming increasingly important."

Valuation practices have also come in for scrutiny. The valuation debate is at its most heated when the German and UK systems are compared. The UK system employs more frequent valuations and uses all transactional data that creates a more volatile market than the German system which results in smoothing.

"UK valuation practices lead to fire sales and thus create more volatility," said one investor. "Does this methodology reflect the market? I couldn't have reacted to recent valuations because the market was not there to react to. Furthermore, if I need to return 5% why do I need the UK system to give me 8%? I need the exit value in the balance sheet; I am a long-term investor so why change?

"Due to international accounting rules the valuation system will move towards the Anglo Saxon model," he concedes. "The result will be more volatility and on average risk and return will increase by about 25%."

With liquidity issues high on the agenda interest in the secondary market is increasing. However as one investor notes "it is very difficult to get into secondary market due to the lack of transparency. A transparent market is a desirable but not a realistic prospect."

He adds: "Generally, if we know a pension fund that wants to exit we will consider a purchase, otherwise the discount may not be deep enough.

"Liquidity issues may mean you won't get a fair market price. Perhaps this is encouraging a shift to direct investment by larger investors and investor clubs. This will be good for fees and will put managers under pressure to perform."

Awareness of sustainability and its importance, meanwhile, is growing. "We're in a new world now where the efficiency of our buildings counts," says one pension fund manager. "So we need to look at our buildings. The demands and challenges in terms of sustainability will be highest in the office sector."

He believes that investors such as the Norwegian Pension Fund Global will take the lead. "Sustainability will be driven by investors' supervisory boards," he says. "Meanwhile managers will be more passive. They think very short-term, especially if they are listed on the stock exchange."