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Tax reforms open up German retail market

Although Germany is often perceived as an economic leader in Europe, the German retail investment scene is still relatively undeveloped in comparison with the US and UK.

A 1997 Lipper survey revealed that as many as 41 per cent of German households kept their savings as simple bank deposits, with only 9 per cent investing in investment funds and 8 per cent in equities.

But sweeping reforms in tax legislation this year are opening the door for sharp growth both in German equities and mutual funds, making it one of the most interesting growth markets in Europe.

Until this year, the marginal rate of income tax in Germany was 53 per cent – one of the highest rates in Europe. As recently as 1998, German corporation tax was 56 per cent, also ranking it as one of the highest-taxed nations in the world.

The new legislation will see the corporate tax burden reduced to 38.6 per cent, taking it below countries such as France, Italy and Japan. The competitiveness of German firms is set to rise, fostering an environment for faster corporate restructure, greater productivity and greater external investment.

Income tax reductions are also set to fuel the German investment scene. The top rate of income tax will be reduced from 53 per cent to 42 per cent over the next five years, leaving people with more cash to invest.

Another tax change which is set to have dramatic effects on the German markets is the abolition of capital gains tax for companies. German companies have been reluctant to realise their cross-holdings in other companies because of the tax burden. The changes will encourage firms to realise their investments, creating a more liquid market.

So far, only two firms in the UK have launched specialist funds investing in the German market. Baring Asset Management has already seen promising performance from its German growth fund, with a return of 139 per cent in the past three years. The fund was recently awarded a AA rating by Standard & Poor&#39s. Chase Fleming Asset Management&#39s Jardine Fleming German trust, registered in Hong-Kong, has been around for a decade. This summer, the firm launched its new Luxemburg-based German opportunities fund.

German opportunities fund manager Alexander Fitzalan Howard says a combination of factors have made Germany an excellent place to invest. “We are very bullish on the prospects for German equities. The appearance of the Neuer Markt is providing a new platform for growth companies in Europe, comparable with the Nasdaq in the US,” he says.

“One of the most interesting things is the number of foreign firms which have listings on the Neuer Markt.I think we are going to see more people investing in Germany and an explosion in the mutual fund market. It is about how fast and how far rather than which direction.”

The mutual fund market is growing at a remarkable rate, with funds under management having almost doubled in the past two years alone. One of the main drivers behind this is the so-called German pension timebomb. Like many European countries, Germany is an ageing country with a state pay-as-you-go pension system. By 2005, the population aged over 60 will be as large as the 20-59 age range.

The government is starting the process of devising alternative pension schemes. Like the UK Government&#39s proposed IPAs, German pensions are likely to be mutual-fund-based. Meanwhile, more and more investors are realising it makes sense to open their own investment accounts as the pension problems have become more publicised.

Threadneedle is another UK fund manager taking an increasing interest in the German market. Having launched its first European open-ended investment company in 1998, it is now becoming a growing force in the German mutual fund market and is aiming to capitalise on the current growth.

Threadneedle communications director Richard Eats says: “The German market is growing substantially. Investors with large holdings in cash and bonds are now starting to move them over to equities.

“As with any market we enter, we are aiming to become a dominant player in the German market. We are now one of the most used foreign groups by IFAs in Germany, which no one would have predicted a few years ago.”

The German IFA market holds a lot of potential and is in a similar situation to that of the UK 15 years ago. IFAs in Germany are largely unregulated and are not tied by legislation but statistics show they are slowly winning more of the distribution. German IFAs are loyal to firms that pay them attention and hostile to those that have a heavy direct-sales side.

With such a backdrop, Threadneedle looks to have a strong chance of becoming a major player in the investment fund market.

Although the Neuer Markt has had a rough few months in the wake of the Nasdaq, the long-term German prospects still look encouraging. With Baring and Fleming having spotted the opportunity that Germany holds, it seems inevitable it will not be long before other fund managers move into the market.


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