Minimum variance bandwagon worries Union Investment

With its roots in Germany's credit unions and co-operative banks, Union Investment, the country's third-largest asset manager, has earned a reputation as a conservative, risk-averse house.

But Alexander Schindler, the board member responsible for institutional clients, is still worried that even the low-risk investment strategies favoured by the Frankfurt-based group's clients are being imperilled by rising markets.

More than a third of Union's equity assets, about €20bn, are managed in minimum variance and minimum volatility strategies, designed to reduce risk and smooth out the bumpy ride stock markets all too often provide.

But Mr Schindler fears that booming demand for minimum variance approaches means the uncorrelated stocks central to the strategy are now becoming more and more correlated, destroying its rationale.

"Everybody is jumping on these minimum variance strategies. You can already tell that the correlation of these stocks [to the wider market] is creeping up to one.

"One has to be concerned about the issue. We are talking to clients and promoting [the idea] of them moving out of that space to outright equities," says Mr Schindler.

More broadly, Mr Schindler frets that Wall Street stocks are already "quite expensive". And while valuations in Europe are "not such a concern", he says, "we have to ask ourselves how far can this go?"

"I am concerned that people will jump on the bandwagon. We wait for Bild to start promoting equity investments, then it is time to get out," he says, referring to the mass-market German tabloid.

For the time being, Union is growing strongly. Net new business rose to €16.2bn last year, up from €10.1bn in 2013, helping push its assets under management up €25.9bn to €232.1bn. Pre-tax profit rose from €399m in 2013 to €485m.

The house now has 1m regular savings contracts with retail investors, a milestone passed in January. Multi-asset and property funds are currently popular with small investors.

Among institutional investors, dividend strategies, property, long-dated fixed income instruments, high-yield bonds and "sustainable" funds are most in demand, alongside minimum variance and volatility.

Given the risk-averse nature of many German investors, both retail and institutional, Union said its growth was assisted by interest rates on cash deposits and German Bunds falling close to (or even below) zero, at a time when rallying equity and bond markets helped its funds generate an average net return of 6.8 per cent in 2014.

"While in the 1990s it was possible to double your capital in 12 years with 10-year Bunds, nowadays it would take 195 years. No one has that sort of time," Hans Joachim Reinke, chief executive of Union, said at the company's annual press conference in February.

Mr Schindler believes this theme is particularly noticeable among retail investors, where "the alternatives like bank deposits or life insurance have become less attractive, therefore the investment fund has become more attractive".

However, in his own specialism of institutional investment, he believes activity is being driven by the machinations of regulators. Citing the likes of the Capital Requirements Directive IV and Solvency II, which govern banks and insurers respectively, Mr Schindler warns that "all regulations have increased the cyclical behaviour of investors.

"That will one day prove to be a real problem for those institutions but also for capital markets," he adds. "We are forced by regulations to act more cyclically than we did before, at least in a down market. On top of that, many institutional investors have been forced into illiquid assets, rather than equity holdings you can hedge in minutes."

Moreover, Mr Schindler believes the eurozone's nascent quantitative easing programme, scheduled to drain €60bn of liquid bonds out of the market every month, will push some institutions into less liquid securities.

Having said that, he believes few European banks - Union's largest institutional client base - will sell their sovereign debt to the European Central Bank.

"Unless they have liquidity issues they will not sell. You don't sell out of a 2.5 per cent coupon and invest the proceeds at zero or a negative yield. Most banking clients I talk to will not sell out." As for who is selling, Mr Schindler sees signs that some Asian sovereign wealth funds are.

He believes Japan's QE programme will have more impact. "[The Bank of Japan] expects [QE] to last for at least seven to 10 years. At the end of the day, they are going to have the whole [government] deficit on the Bank of Japan's books," he predicts.

As a result, Japanese institutions will be squeezed out, forcing them to invest huge sums abroad. "That is why I believe that even if the [US Federal Reserve] raises rates, the yield curve will remain flat, because of the number of investors," says Mr Schindler. Although he does see one countervailing force, that of China looking to reduce its political dependence on the US by easing up on Treasuries and making more direct investments in the UK and continental Europe.

At present, all but €20bn of Union's assets are sourced from outside Germany, much of that from other German-speaking markets, but it is seeking to correct this.

Quoniam Asset Management, Union's quantitative subsidiary, opened an office in London in August. Union is considering using it to establish itself in the UK, not only in the search for British clients, but also Nordic and Middle Eastern investors that use London as a hub. Poland and Asia are other important markets for expansion.

If Mr Schindler's prognosis for the German economy proves accurate, Union may have even more reason to embark on international expansion.

He believes Germany's current economic leadership of the eurozone is largely the result of labour market reforms pushed through by Gerhard Schroder, the chancellor at the time, a decade ago.

However, he fears the current generation of politicians may be about to throw this advantage away.

"Germany is doing everything to dilute its competitiveness," says Mr Schindler, who cites a decision to lower the retirement age to 63 for some workers and pressure for across-the-board pay rises.

"I forecast that Germany is going to lose its competitiveness and again in five years we will be the ailing man in Europe as we were 10 years ago," he says.

. . .

BornMay 5 1957, Germany

Education1983 Law degree, Hamburg University

Total payNot disclosed

Career 1987 Portfolio manager, Commerzbank, Frankfurt

1990 Deputy head of fixed income, Commerz International Capital Management

1991-94 Head of client relationship management/marketing, Commerz

1994 Managing director and executive officer, Commerz

1998-2003 Managing director, asset management, Sal Oppenheim

2004 to present Member of the executive board, Union Asset Management, Frankfurt

2007 to present Member of board of directors, BEA Union Investment Management, Hong Kong

2013 to present Vice-president, Efama

. . .

Founded 1956

Assets under management €232bn (as at end of 2014)

Employees 2,500

Headquarters Frankfurt am Main, Germany

Ownership Owned by cooperative central banks DZ Bank and WGZ Bank

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