Crisis Pushes Down Returns: Big Investors Don't Know Where to Put Their Cash
As the debt crisis makes government and bank bonds look increasingly unattractive, institutional investors are finding themselves with plenty of cash but nowhere to put it. Pension funds and insurance companies are desperately looking for safe havens which promise even modest returns. But some argue that the crisis creates opportunities for those with an appetite for risk.
The man who controls more than 450 billion ($558 billion) is wearing purple, pink and red striped socks and a polka-dot tie, and his bald head looks as if it has been polished. In other ways, too, Yngve Slyngstad is a relaxed Norwegian type. He laughs a lot and has a tendency to inject nuggets of irony into his responses.
So what's it like to be one of the world's most powerful investors in 2012? "In the past, we searched for risk-free returns." He pauses for effect. "Today we know that what we mainly have are investments with return-free risk."
It's a common experience for the 49-year-old investor these days. His constant challenge is to find ways to invest a lot of new money and reinvest old money.
As head of the Norwegian sovereign-wealth fund, Slyngstad collects his country's oil revenues, which currently total more than 100 million -- per day. The fund is supposed to use these revenues to provide the country with prosperity for the long term. It's no easy task, because the government expects Slyngstad and his staff of more than 300 people to generate a 4 percent return on investment.
In the past, investment professionals would have dismissed this requirement as uninspiring. But times have changed. Between 1999 and 2007, the Norwegian sovereign-wealth fund achieved an average annual return of almost 6 percent, but during the last four years it has only been about 1 percent on average. "The situation in the financial markets has become extremely difficult," says Slyngstad. Interest rates are plunging worldwide, and Germany, more than any other country, is benefiting from the fear that the euro zone could break apart.
Borrowing Money for Free
Now that a Greek exit from the monetary union has become a realistic option, Spain is desperately fighting to retain its financial independence and the citizens of Southern Europe have started emptying their bank accounts, the flight to Germany -- perceived as Europe's safest haven -- has intensified once again.
In the week before last, the German finance minister borrowed money for two years, without having to pay a single cent in interest. Even investors lending the German treasury money for a decade are currently satisfied with a premium of only 1.2 percent per year. The yields on US Treasury bonds and Japanese debt securities are at similarly low levels.
But what is helpful to many a finance ministry is frustrating for investors. When today's very low bond yields are adjusted for inflation, many investors end up with negative returns. Investing money is becoming tantamount to the destruction of assets, because there are few investments that actually produce any returns.
Professional investors around the globe currently manage more than 60 trillion, more than twice as much as they did 10 years ago. There is talk of an "investment emergency" in the international financial markets, and the most disconcerting thing about it is that the problem is not affecting billionaires or greedy corporate raiders as much as the biggest players in the financial market: sovereign-wealth funds like Norway's, Japanese insurance companies and US and German pension funds.
Most of these players are managing the money of small investors, billions in assets with which they do not want to gamble. Instead, their objective is to invest the money so that they can eventually pay out a sizeable pension or the proceeds of a life-insurance policy to their customers. However, this usually works only if the money is invested safely, while at the same time generating yields of a few percentage points.
But in many cases, such yields are no longer realistic, now that Greece's creditors have had to write off a large portion of their claims. As a result, a basic tenet of investing has been destroyed. The bonds of major industrialized countries were considered risk-free investments for decades. But now it's become apparent that bond investors can also lose their money. No one knows what a safe investment is anymore.
Bonds, Stocks or Cash
For Frankfurt banker Friedrich von Metzler, 69, this is a long-awaited triumph. Metzler has always preached modesty to his customers. Oil portraits of his ancestors hang on the wall in the conference room at the headquarters of his private bank. The bank has been in Metzler's family for almost 350 years, and it has survived plagues, hyperinflation and two world wars. Metzler's private customers have three choices for investing their money: bonds, stocks or cash. "If that isn't enough for someone, he'll have to go to the competition," says Metzler.
This attitude doesn't deter many of his wealthy clients. On the contrary, business is better than ever. Recently, Metzler has had to reiterate his mantra, which runs counter to human greed, again and again: "In the long term, preserving one's assets in real terms is already a success."
The only problem is that even this has become a utopian goal for many players in the financial markets. Take, for example, German insurance companies, which operate in a highly regulated industry. After the market crash in 2000, the companies had to sell the majority of their stocks. They are obligated to keep at least two-thirds of their customers' assets in absolute safe investments. And this, according to the general consensus, still means government bonds with the highest credit ratings.
They are only permitted to invest a third of their managed assets in other types of investments, from real estate to corporate bonds to hedge funds. This is their play money, so to speak. But even if they take high risks with these assets, the average total return for newly invested money is currently no more than 3.5 percent.
This creates a huge problem in the long term. The insurance companies still have many older securities on their books, which produce higher returns. But the new investments are far less profitable, and as a result the average return on investment is falling -- slowly, but steadily.
In addition, millions of the insured have taken out policies that guarantee them annual returns of 4 percent. If an insurance company fails to meet this target, it is forced to draw on its reserves. This, in turn, increases pressure on the industry to achieve higher returns.
Getting Out of Bonds
It's a challenge with which Volker Blau is only too familiar. Blau works for the US investment firm PIMCO, where he manages insurance premiums for German insurance giant Allianz and other European insurance companies. An insurance company in Germany, says Blau, is like a Porsche that can only be driven in first gear -- in other words, it has plenty of horsepower but limited possibilities for action. The total value of German life insurance policies alone amounts to 734 billion.
When the conservative insurer Allianz acquired PIMCO 12 years ago, it was an attempt to at least shift into second gear and accept the risks associated with a bumpy road. But what happens when that road becomes increasingly impassable?
What about government bonds? "Even before the euro crisis, many insurers started getting out of government bonds, where returns have been very low for years," says Blau.
Stocks? "The insurance companies' equity investments are at historically low levels," Blau says. Recently, the industry has only invested an average of 3.3 percent of its assets in stocks. Even industry giants like Allianz and Munich Re burned their fingers in the 2000 stock market crash.
What to do with all the money? Blau is unperturbed. There are many fixed-interest investments that are about as safe as German government bonds but generate higher yields. For example, 10-year covered bonds, known in German as Pfandbriefe, are paying about 2.5 percent interest in Germany, while similar products in other European countries offer higher returns. But bonds that are collateralized with Spanish real estate also come with higher risks.
Search for Alternatives
That's what happens when one sets out on new routes. Sometimes it isn't quite clear whether they are merely the old, wrong tracks.
In the past, money manager Blau had no qualms about buying bonds issued by banks. But since the Lehman Brothers bankruptcy and the Greek disaster, no investor is willing to lend banks money without demanding substantial collateral in return. Instead, Blau is increasingly making the kinds of investments that banks used to make, in real estate, for example. When Deutsche Bank sold its freshly renovated twin towers in Frankfurt to its fund subsidiary DWS last year, the financing came from Allianz.
There is little Blau isn't willing to explore in his search for investment returns, from infrastructure projects to wind farms. The latest craze is, of all things, parking meters. Two years ago, Allianz and a group of partners invested 1 billion in a company that operates parking meters in Chicago. And while banks shy away from funding Germany's cash-strapped local authorities, insurance companies are increasingly interested in municipal bonds. German life insurer R+V Lebensversicherung recently bought 20 million in bonds from the western German city of Wiesbaden.
Corporate bonds and the sovereign debt of emerging economies, once something for the intrepid, are suddenly seen as safe havens. And while high budget deficits, debts and small foreign-currency reserves deterred many investors in the past from investing their money in booming regions, countries like Brazil and South Korea have since acquired reputations as credible borrowers. "In some cases strong industrial companies, as well as emerging economies, can offer more security than some government bonds from industrialized nations," says Blau.
Forests and Shopping Malls
Daniel Just is under even more pressure than insurance-company managers to generate a decent long-term return. Just is the head of investments at the Bayerische Versorgungskammer pension fund, which manages 55 billion in assets. For the members of many professions, including doctors, attorneys and even chimneysweeps, the contributions they make to pension funds such as Bayerische Versorgungskammer are often their only pension plan. If Germany were afflicted with low interest rates for the long term, the consequences would be devastating for millions of people.
The effect of compound interest cannot be overestimated. If a person saves 500 a month, he will have accumulated close to 350,000 after 30 years, assuming an annual return of 4 percent. If the return drops to only 2 percent, the end result drops by about 100,000.
To address this problem, Just chose a revolutionary path for Bayerische Versorgungskammer years ago: investing in emerging economies. The idea is that young, growing economies in Asia and Latin America will fund the pensions of Germany's aging society. Because of Just's investment approach, Bayerische Versorgungskammer is not only the proud owner of forests in the United States today, but also owns commercial real estate in China and Brazil, as well as a shopping center in Chile.
Anything that promises long-term, consistent cash flows is considered attractive. A competition among major investors for real assets such as property and infrastructure projects has already begun, and prices are going up accordingly. "It's becoming more and more difficult to find attractive investments," says Just. In this sense, the new problem in the investment world is the same as the old one. The financial industry is like a herd that runs in the same direction all too often.
'I'm Really Enjoying the Situation'
"It's always wrong to do what everyone else is doing," says Hendrik Leber, sitting in his sparsely furnished office in Frankfurt's banking district. He uses a few colored markers to illustrate his point. Leber draws a grid onto a piece of paper, using the blue marker. Each of the roughly 50 compartments, he says, represents an investment opportunity -- from government securities, to corporate bonds from developing countries, to a commodity like gold.
At the moment, everyone is pouncing on a few compartments, especially the one containing German sovereign debt. He draws a thick, round circle around that compartment.
"Most people fail to see how highly attractive the rest of the market is," says Labor, who manages a fund with 1.1 billion in assets. "I'm really enjoying the situation," he adds. Whenever his investment policy allows, he invests according to the motto: If you're going to take risks, you may as well make them big ones. For example, he has invested in bonds issued by Irish banks.
His target of choice at the moment is a country everyone else is avoiding like the plague: Greece. He has purchased shares in several Greek companies, including those of a lottery provider. Leber has a very rational explanation for a move that seems more than audacious: "The Greeks have always gambled, and they'll continue to do so."
Translated from the German by Christopher Sultan
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