Fund guidelines of DSW

The following guidelines have been developed by DSW to help protecting the interests of the funds investors. These guidelines are inteded to set a standard for all funds. They are based on the 'Mutual Funds Guidelines' of Euroshareholders, a confederation of European shareholder associations to represent the interests of individual investors at EU-level and address to all fund companies which distribute their shares in Germany. Spirit and purpose of these guidelines is an increasing transparency towards for the fund investor but also a strengthening of the position of the fund managers.

No. 1:

The management of the funds has to follow the legal principle of ‘acting independently in the exclusive interest of the owner of the fund’ in the day-to-day business. This includes the ‘best execution’ principle as well as fairness and transparency concerning related party transactions.

Beside the ‘business judgement rule’ the fund management has to observe the ‘principles on monitoring investment fund managers’, developed by IOSCO in 1997. Besides, it is advisable to disclose and document those principles to the fund investors.

In this connection, the following facts are of particular interest to the fund investor:

a. Observation of the principle ‘best and in-time execution’

While executing a transaction, there may be the risk that the fund manager does not always trade for the best conditions. For instance this could be the case, if transactions are made by an in-house-market maker or a broker. Therefore, the fund management is not only obliged to choose the best execution but has to disclose whether and to what extent this principle has been taken into ac-count. Furthermore, the transaction has to be executed ‘at arm’s length’. This would be done by proving how at this time the compa-rable costs and prices of different brokers looked like.

b. Allocation to fair conditions

The fund management has to ensure that orders are allocated according to fair conditions. For example the fund management has to ensure that the allocation of the transaction will not be delayed until the following price movements of shares become obvious, since thereby other customers would be favoured above the fund investors.

c. No churning

The fund management has to ensure that no churning will take place. An excessive transaction frequency can have a negative effect on the fund assets and lead to high charges, which again curtail the fund yield. Exemplary is the handling in Great Britain, where the trading of newly registered funds is limited by a specifically low percentage.

d. No soft commissions

The fund management has to avoid soft commissions, if possible, because of their negative impact on the fund assets. In principle, there is the risk that the fund management commits itself to transac-tions with only a certain party. In this case it is at least doubtful if the principle of best execution is really observed.

e. Disclosure of ‘related party’ transactions

In case the fund management realizes transactions with related parties in the name of the fund, these transactions should be executed in the best interest of the fund. These conflicts of interest can especially come up in cases where the fund management is a subsidiary of a bank or the bank holds the majority of its shares. In these cases, possible conflicts of interest could be avoided by so called ‘Chinese walls’.

Information on the observance of ‘Chinese-Walls-Principles’ by internal monitoring systems have to be accessible to the fund investors. Other conflicts of interest can arise in cases where the fund company appoints a broker or a bank who or which has an ownership connection with the fund. The fund investor then has to be informed how it is ensured that all transactions with this bank are realized ‘at arm’s length’.

Furthermore, in cases of the subscription to newly issued shares the fund management has to ensure that it acts solely in the best interest of the fund and its investors. In this case, there is a risk that a fund company, which is a subsidiary of one of the consortium banks subscribes to newly issued shares although they do not fit into the investment strategy or are disadvantageous for the fund in any other way.

Further, the investment of funds in pre-IPOs has to, if at all, take place only while observing strictest limits.

Besides, the fund management has to ensure that fund’s employees do not carry out any transactions for themselves, which in any way collide with the fund’s responsibilities. This should also apply to personal investments of the fund management parallel to the engagement of the fund in participations not yet listed at a stock exchange.

Insofar, it is advisable to develop beforehand ‘ethical employee principles’ to avoid conflicts of interest.

To strengthen the investment funds’ independence and to clarify the relations to other financial institutions, investment funds should disclose all substantial contractual relations to related parties. Of special interest is mainly the transaction’s extent realized with those related parties.

Within the scope of the 4th Financial Market Promotion Act (4. Finanzmarktförderungsgesetz) (revised form of § 10 clauses 6 and 7 KAAG) the topic ‚conflicts of interest’ and their solution is expressly mentioned. The new rules do not only require the installation of guidelines to handle those conflicts of interest by the competent supervisory authority but also the investment companies themselves have to develop rules to solve these conflicts of interest in future.

No. 2:

To improve independence and efficiency of the fund man-ager’s work the fund has to develop own Corporate Govern-ance guidelines. A Corporate Governance committee shall ensure the compliance with these guidelines.

The EU directive on investment funds, called 'Undertakings for Collective Investment in Transferable Securities' expressly provides that ‘with a view to their respective roles the fund management and the depository bank are obliged to act independently and in the only interest of the fund investors’.

Possible conflicts of interest, which may affect the interests of the fund investors are included in the IOSCO report of May 2000 on the topic ‘conflicts of interest at investment funds’.

From DSW’s point of view, transparency is of major priority to avoid such conflicts of interest. This means that type and extent of the relations as well as the contractual partner have to be disclosed to the fund investors. Further-more it has to be ensured within the fund that the management is independent. In DSW’s opinion own guidelines are required, which precisely regulate how to avoid possible conflicts of interest and how to deal with them if they occur. To supervise the compliance with those guidelines a corporate governance committee should be set up. The fund’s management should disclose to this committee how far it has taken the independent and exclusive interests of the fund investors into consideration while executing their businesses and exercising their voting rights. This committee, which has only an advisory function should consist of a majority of up to three ‘independ-ent’

representatives.

‘Independence’ in this context means: without any former or actual relations to the fund company or the Group’s parent company or the majority shareholder.

Examples of such potential conflicts of interest are especially given in the case a bank owns the majority of the fund or if the fund company is one of the bank’s subsidiaries. Another conflict of interest can arise if the Group’s parent company (bank) is at the same time the fund’s depository bank and if, furthermore, the fund’s supervisory board has a majority of bank representatives. It would anyhow be desirable if more fund companies chose a majority of independent members within the supervisory board.

No. 3:

The fund management has to disclose the voting policy of the fund company.

Today, investment funds can hold important stakes in the stock market and can thus exert a considerable influence on the company. Because of this influence, the responsibility of the fund management grows with regard to this influence. Therefore, investment funds should in principle pursue their own corporate governance policy and explain what principles they pursue while executing their voting rights. Also they should be obliged to act exclusively in the interest of the fund investors, while executing their voting rights. A disclosure of this voting policy would then lead to a higher responsibility of the fund management as a participant of the capital market while exercising due care.

Today, it is an undisputed fact, that voting rights in shares are of an economic value. In the interest of the shareholders they should therefore be treated as assets. This requires the development of own ‘Voting Principles’ which should then be disclosed to the shareholders. These voting principles are a main part of a well functioning cor-porate governance structure inside the company, which ensures that the fund management meets their duties.

No. 4:

Each fund has to exercise its voting rights (deriving from the funds’ shares) in the interest of the fund.

According to § 10 para. 1 of the German Law on Investment Trusts (KAGG) a fund company shall in principle exercise its voting rights by itself. The exercise of voting rights enables the fund companies or their management to play an active role with the companies in which they hold a stake. Investment funds should essentially intensify this active role in the fund investors’ interest. This means, that fund companies do not only supervise the shares of the companies they have in their portfolio, but also ensure that the voting right will be exercised. For this, the personal attendance of the fund representa-tives at the AGM is strongly recommended.

Apart from the principles of the exercise of voting rights fund companies have to publish information on how they will exercise the voting rights they are entitled to, how they actually exercised them and to what extent they voted in the fund investors’ interest.

This requires a reporting on the following items in the annual reports and/or on the fund’s website:

1. The extent of the exercised voting rights (at which AGM was the fund represented, with how many votes).

2. The fund’s exercised votes in those cases, where they dissented with the proposals of the company’s managing board. By this, it becomes transparent to the investors, if and to what extent the fund actually acted in their interest. Fund companies which are not able to exercise their voting rights for themselves (for whatever reasons ) have to appoint an ‘independent’ proxy solicitor to the current Annual General Meeting. This corresponds to the recommendations of the Government Panel on Corporate Governance conducted by Prof. Baums (see report of the Government Commission, note 128).

The new 4th Financial Market Promotion Act has modified § 10 para. 1 clause 4 KAGG, stating that an independent proxy cannot be authorized only for one AGM but permanently in order to exercise the fund’s voting rights. However, the explanation of the draft makes clear that this fact “does not release the investment trust from the duty of managing the voting behaviour of the representative carefully, for example by general guidelines or voting instructions or in special cases by single instructions”.

Beyond, funds should use the instrument of electronic voting as a further alternative.

No. 5:

Funds have to agree on unified standards for accounting as well as on a standardized cost definition (like TER) in order to increase the comparability for the fund investor.

Unified standards on accounting lead to a clear increase in the investment funds’ comparability of the return/cost account. Furthermore, a cost definition like TER should be equally defined for all investment funds. In principle, TER is an effective instrument for the investment funds’ transparency on costs. TER describes the weighted average costs of the investment in funds for any time period. This data can not only be calculated at the end of the fund’s financial year but also for any time period throughout the year. Basis of TER calculation are the Total Net Operating Expenses (all charges and operating costs effectively taken from the fund’s assets in a certain time period or the fiscal year). Furthermore, the total amount of the management fees for this time period has to be taken into account. It is especially important that TER will be split up into the different cost groups (costs for the management, costs for the depository banks, transaction costs, costs for marketing, costs for information technology, costs for the prospectus, costs for the auditors, advisory costs, distribution costs etc). Only a unified definition of TER and the connected cost groups will make it an important instrument for cost transparency.

In the KAGG, the legislator did not establish any rules on cost transparency. From the fund investors’ point of view it is regrettable that investment trusts are not obliged to inform the investors in detail what their investment at a certain time costs or has cost.

Furthermore, fund investors are not entitled to a transparency of the costs in relation to the volume and the length of the investment (see § 24a para. 1 clause 3 no. 3 KAGG). The expenses account, published in the annual reports, informs only on management costs, on possible success-based compensation of the management board and on ‘other’ expenses.

Fund investors miss information, for example on transaction costs. A higher cost transparency should not be regarded as a disadvantage of the fund companies but as an instrument to strictly distinguish themselves from competitors.

No. 6:

Funds have to take care of the required cost transparency and the principle of ‘fair transparency’.

The transaction costs, the fees for the depository bank and all costs subtracted from the funds’ assets and herewith reduce the yield of the current fund have to be disclosed.

A transparent structure of investment funds fees first of all leads to an enhanced comparability and furthermore shows the fund investor who is paid how much for which performance. Even more a lot of fund investors take the agio as a main criteria. Yet, the fund sellers’ competition has meanwhile lead to a decreasing agio. Plus, there is the possibility to completely avoid the agio via Exchange Traded Funds although the regular transaction charges still arise. But since the agio is a fee which has to be paid only once, it is therefore not as important for the fund’s yield as other annual costs, like the management board’s compensation. Taking this into consideration, it is especially interesting to the fund investor to see an increase in the fees, especially the management’s fees in the recent 2 years. Despite the fact that fund investors may be informed about the new fees by the Federal Gazette (Bundesanzeiger) and the fund report, a timely information on the respective website of the fund would be more important in order to show the immediate effects on the yield.

Cost transparency also means a disclosure of additional and hidden earnings, especially resulting from securities transactions. It still seems to be a known practice of foreign companies to demand, at least partially, for the reimbursement of the due provisions or an appropriate participation for making securities transactions via broker or the parent bank. A complete disclosure of the transaction costs – as DSW requests – would not only lead to a comparability with other funds with respect to their transaction fees but also fund managers then would seek the broker who executes the transactions as

cost-effective as possible.

No. 7:

Funds have the duty to compare the investment fund’s performance, namely with the relevant index or a comparable fund in the identical time period.

It is no secret that many fund managers have serious problems to beat the certain index the fund is based on over a period of several years. Therefore, it is of high importance to the fund investor if the fund manager was able to beat the relevant index or comparable competitive products – at least for a limited time period. In any case, fund investors should be aware that the fund’s performance results are related only to the past and are no indication for a future performance of the fund. For this reason, ratings of fund-rating agencies should be taken as another orientation for the fund investor.

In principle, the comparison of the performances’ presentation should start from the fund’s offering. A comparison over fixed time periods, e.g. 1 year, 3 years and 5 years, is advisable. Not desirable is a restriction to time periods especially chosen by the fund management. Promoting with performance numbers which are no longer updated should also be avoided.

DSW assumes that all investment funds are based on the internationally accepted GIPS standards. GIPS (Global Investment Performance Standards) contain the 5 main elements for the presentation of performance standards, namely input data, methods of calculation, construction of composition, standards for disclosure of performance as well as the presentation and the reporting (see IOSCO GIPS standards 2000).

No. 8:

In principle, all funds shall support fund ratings by professional rating agencies to give fund investors a guidance on the selection of funds.

In Germany, nowadays more than 5,000 investment funds are offered. It is almost impossible for the fund investor to select the adequate fund and investment strategy. The increasing number of fund offers and at the same time the increase in the fund distribution via direct banks lead to the fact that less fund investors ask for a direct adviser but nevertheless need guidance. Hit lists of the funds’ publications are of no great support because they are only related to the past and give no indication for a fund’s future performance.

Therefore, a rating by a professional rating agency can give orientation. In Germany, agencies like Morningstar, Standard & Poor’s or Feri Trust Fund Rating have established professional rating systems. However, most rating companies base their ratings on different standards: whereas for Standard & Poor’s and Morningstar the fund has to exist for at least 3 years, Feri Trust demands a time period of at least 5 years. Here, a standardization of the rating standards would be desirable for a better comprehension for the fund investors. To the fund investor it is interesting, that beside the present performance there is a risk indicator taking the various risk aspects like tim-ing risk or risk of loss into account. Additionally, so called ‘soft’ factors like the fund management, the investment strategy and especially the investment segment which can be crucial for the fund’s performance are being closely watched.

The annual costs of a fund are also being taken into account. However, the investor should not forget that a fund rating is not a recommendation to purchase the fund. Nevertheless, from DSW’s point of view those funds which are independently assessed by different fund rating agencies can be of special interest to the investor.

Therefore, watch lists of rating agencies are important to the investor. They show changes in the performance, the risk but also possible changes with regard to a change of management, strategy and the rating. The rating agencies’ results can usually be seen via the internet and are published in financial magazines.

No. 9:

Funds have to disclose all relevant risks and have to inform on a risk classification system.

Beyond the legal rules in Germany no guidelines or principles exist so far on limits for fund investments with a view to market risk, contractual partner risk, liquidity risk, risk of the day-to-day business or legal risks connected with an investment fund (see the summary of answers in the IOSCO questionnaire on ‘Principles and Best Practice Standards on the infrastructure of fund managers’ decision making).

From the fund investor’s point of view it is desirable to develop unified risk classification systems to facilitate the reporting on risk classification. Besides, the fund management has to care for a sufficient allocation of risks. Therefore, the fund’s investments in narrow market segments (for example the Neuer Markt) should be kept as low as possible and under-proportional in order to avoid from the very beginning the so called ‘lump risk’.

No. 10:

Funds are obliged to develop uniform information standards in the interest of the fund investors to ensure a comparability between the funds.

The enhanced standards should not only apply to written information (annual reports, interim reports, quarterly reports and product brochures) but should also give the fund investor current information via the fund’s website.

From the fund investor’s point of view information on the following topics are necessary:

1. the fund’s principles of investment and the current achievement of the fund’s investment strategy,

2. the securities transactions, so far executed,

3. the performance, so far reached,

4. a detailed list of the costs,

5. ratings of fund rating agencies, if they exist,

6. details on governance structures within the funds, which include information on own corporate governance guidelines and the corporate governance committee’s composition,

7. measures to avoid potential conflicts of interest,

8. the principles on voting and the result of the exercise of the votes.

It is DSW’s objective to make the present selling prospectuses more readable for investors and give short, but timely and precise information via the website.

The fund guidelines, developed by DSW, address to all fund companies which distribute their shares in Germany. These guidelines are not only directed towards a visible increase in transparency for the fund investor but a strengthening of the position of the fund managers.

Already in February 2002 ‘Euroshareholders’ in Brussels introduced – on a European level – its ‘Mutual Fund Guidelines’ for Europe and all European fund companies. The guidelines of DSW are essentially guided by those European guidelines already published.