A sophisticated risk management system as a foundation for success
Integrated management of opportunities and risks
In the last few years, the real estate market has proven in dramatic fashion that it is not a one-way street with steadily increasing prices — it involves a considerable level of risk, just like other capital markets. Can a professional risk management system prevent something like this? Certainly not. However, a risk management system can be used as a systematic and integrated approach to identifying and assessing opportunities and risks based on a wide range of criteria, thereby bringing them to attention and allowing them to be managed.
Risk management plays a particularly important role in asset management: In addition to analysing risks that are already known, new risks must also be quickly identified and actively managed. Risk management therefore needs to be networked, integrated and forward-looking. This is important for investors because it means the risk culture framework developed with the Deka Group sets guidelines for dealing with risks responsibly. What is particularly important for us is that our organisational structure has made risk management independent of portfolio management and the front office units for acquisitions and sales and real estate management right from the start.
As a result, Deka Immobilien has gained many years of experience, expertise and in-depth knowledge in 27 markets. Deka Immobilien can also take advantage of the expertise of its real estate specialists and its related sector expertise to compensate for the limited availability of data in some areas. This allows us to achieve optimal results for our investors.
Maintaining a holistic view of risks
Deka Immobilien uses a comprehensive, fully integrated management and risk reporting system to maintain a holistic view of risks at product level and business division level. Our business policy and investment decisions for our products take sustainability risks—also referred to as ESG risks—into account at all times. Due to their effects, however, these are always viewed in the context of the other risk types. Sustainability risks are managed using procedural measures that are implemented as part of the associated strategies and custom-tailored for each activity. While business risks and operational risks are the main focus at the business division level, four risk types are considered at the fund level (see chart).
This tried-and-tested risk management system allows risks, results and products to be managed both strategically and operationally. The risk reporting system provides regular reporting on identified and assessed risks and the measures introduced for managing risks. It is continuously improved, including in terms of integrating sustainability risks. As a result, investors can be sure that in addition to macroeconomic risks, other sources of risk, such as external market effects or regulations, are also promptly included and optimally accounted for in the analysis.
Continuous identification, measurement and management of relevant fund risks
Whether for real estate mutual funds, institutional real estate funds, direct real estate funds, funds of funds solutions or loan funds, Deka Immobilien offers an extensive feature-rich range of real estate and loan funds for both retail and institutional investors.
Our sophisticated risk management system (RMS) plays an important role in the related processes and products by identifying, measuring, managing and monitoring significant risks in the investment strategies of the funds. In this respect, the RMS is a formal overarching framework that defines the rules and responsibilities for all employees.
Our risk managers are always there
Firstly, all of the units concerned are involved in risk management and take part in the decision-making required at all stages, from product development and fund management to property management. In addition, our Risk Controlling unit also provides assistance to this value chain at all relevant levels of risk. To ensure a balanced discourse in terms of opportunities and risks, this unit is hierarchically and functionally independent of the operational areas. Using modern systems and models for risk assessment as well as individual security analyses allows Deka Immobilien to manage its products efficiently.
Risk management at all points in the value chain
Fund risk management and controlling in practical applications
Risk management at Deka Immobilien
Risk aggregation is one of the key challenges for modern risk assessments for real estate funds. This is because properties are highly individual assets and—unlike securities, for example—are very difficult to assess quantitatively.
Deka Immobilien uses a combination of quantitative and qualitative elements to gain a comprehensive picture of all opportunities and risk in spite of this.
A quantitative model in the form of a multi-stage ➥ Monte Carlo simulation, supplemented by qualitative factors, forms the "core" of risk measurement at Deka Immobilien.supplemented by qualitative factors, forms the "core" of risk measurement at Deka Immobilien.
Even though there is no regulatory requirement for this, Deka Immobilien also uses a similar product process for each new asset being acquired for the investment funds that combines comprehensive quantitative and qualitative analyses.
Risk controlling at Deka Immobilien
One of the main duties of modern risk controlling at Deka Immobilien is developing and continuously improving methods for the risk types used. This forms the basis for ongoing risk monitoring, independent reporting including stress analyses and limit monitoring.
Due to the long-term investment horizon, the new product process (NPP) is critically important. Therefore, in addition to the NPP that is required by the regulations, Deka Immobilien has also implemented a product process (PP) for assessing each individual asset in which all of the functional units involved work together in an interdisciplinary manner. This ensures that every asset receives a comprehensive risk assessment that far exceeds regulatory requirements, even at the acquisition stage. In addition to the results from due diligence, the PP and NPP also include a wide variety of stress scenarios for calculating profitability and risk measurement results (two-stage Monte Carlo simulation), combined with qualitative factors. In our view, this is an key indicator of the high quality provided by Deka Immobilien, as it allows opportunities and risks to be taken into account and analysed optimally for each investor.
The strategic objectives of the funds are also regularly reviewed during the holding period based on the existing situation, knowledge gained in the past financial year and future performance forecasts. This ensures that investors can continue to achieve the best possible results.
Effective risk controlling extends all the way to reporting at Deka Immobilien. In addition to differentiated risk measurement, it also includes critically reviewing and managing regulatory (risk) models for our institutional investors, which include, for example, savings banks, private banks and Volksbanks (cooperative banks), and portfolio risk simulations during the portfolio selection process. These tailored services are customised to meet the specific needs of each of our clients. Our modern approach to risk management makes us an experienced reliable partner in the real estate sector and provides institutional investors the freedom to take the actions they need for their core business.
As an experienced real estate specialist, we have the in-depth knowledge and extensive management expertise required for the different markets and investment cycles, and this expertise is being continuously improved. For example, Deka Immobilien is actively involved in current developments and discussions, ranging from participating in associations such as BVI and ZIA to involvement in research and teaching.
Integration of sustainability risks
At Deka Immobilien, we are committed to operating responsibly with a high standard for sustainability in our portfolio of products and services. We therefore take sustainability risks into full consideration. We use a variety of strategies and processes to ensure risk monitoring of sustainability-driven developments or events during the investment process and the entire asset holding period in order to minimise their impact. A distinction is made between Environmental (E), Social (S) and Corporate Governance (G) risks — ESG for short.
A variety of models are used to integrate ESG risks into the investment funds, ranging from limit management systems and scoring systems to integrating such risks into Monte Carlo simulations. A scoring system is used to continuously monitor Social and Governance risks, while Environmental (E) risks are divided into physical and transitional risks during risk measurement.
Physical risks have a direct impact on the properties and are physical consequences of the effects of climate change, such as rising sea levels. This type of risk can be acute or the result of long-term changes.
Transitional risks related to the environment can occur for various reasons, including in connection with the transition to a low-carbon economy or, more often, regulatory interventions. For example, they can lead to price increases or shortages of fossil fuels, e.g. CO2 pricing or a ban on operations when certain CO2 or energy consumption limits are exceeded.
All risk types are taken into account in the investment process and ongoing risk monitoring where necessary. In addition to direct return risks, adverse market and climate developments and regulatory changes are also taken into consideration.
Optimised risk systems are used depending on the product and are chosen based on the required objectives, available data sources and specific client needs. "S" and "G" risks can be measured across all product lines.
Risk management for different product categories
Real estate funds
Risk measurement for direct real estate funds focuses on macroeconomic parameters applicable to all properties, such as market rents, exchange rates, interest rates, yields, inflation, CO2 price changes and climate scenarios that are provided by the DekaBank Economics department. They are simulated using Monte Carlo simulations. In addition, property cash flows are calculated at the property level using macroeconomic variables, the current leasing situation and possible climate risks. The goal is to plan variance risk and identify risk avoidance strategies by using a large number of individual scenarios taking risk distributions into account.
Baseline scenarios are also used to perform stress tests: These concern influencing factors such as vacancy rates, liquidity, tenant default, property returns or reductions in the period of use. Combined scenarios involving simultaneous changes to multiple risk factors are also calculated and used in our risk model in addition to sustainability risks.
One special feature is integrating physical risks (see figure) that are identified and assessed on an individual basis for specific locations using an appropriate climate forecasting tool and included in the overall risk analysis.
Physical risks: Simulation of loss states due to climate change
To determine transitional risks, energy and CO2 consumption values are calculated for each property and compared to a benchmark—for example, the Carbon Risk Real Estate Monitor (CRREM) paths—taking into account property measures such as maintenance. The resulting "Carbon Delta" is assessed accordingly as a monetary risk (see Transitional risk chart). The primary goal of this analysis is to minimise the risk of "stranded assets" — in this case, real estate for which the value drops sharply in a relatively short period of time due to environmental and climate-related factors.
These analyses are performed both during the acquisition process and over the entire holding period, so that potential risks can be identified early and mitigated accordingly.
Real estate funds of funds
For fund of funds products that invest in Deka-owned target funds, we build on the risk model for direct real estate funds and analyse the data at the aggregated fund of funds level.
When exchanging data with other management companies, we rely on industry standards (BVI real estate fund of funds reporting) and actively participate in the development of these standards. The data supplied by external fund providers is converted to a format that is compatible with our simulation model and used in a manner similar to our direct real estate funds. When integrating sustainability risks, we also use scoring models specifically designed for this purpose, as the data still presents a challenge for the entire industry
The structure of loan funds differs considerably from the other product types in our business division. Loan funds finance a broad range of assets and projects, such as real estate, infrastructure projects (e.g. wind farms), aircraft and ships.
Credit risk is particularly important when investing in loans, as a deterioration in borrower credit ratings or default can have a negative effect on the loan fund. Risk management for these products therefore mainly focuses on monitoring the ratings of the exposures and ensuring that suitable collateral is provided, so that an in-depth assessment of the current creditworthiness and future changes can be performed for each borrower. Loan exposures are also monitored using a variety of early-warning indicators to identify signs of deterioration in financial circumstances and the value of the collateral provided.
These analyses make use of the extensive back office lending expertise that Deka Immobilien has gathered. We use a variety of scenarios ranging from rating downgrades across all loans to defaults on individual loans to ensure that our assessments of the effects of credit risk on our loan funds are optimal.
In addition to credit risk, market price risk is also important for loan funds. Loan exposures are subject to currency risk, interest rate risk and spread risk. Derivatives can be used to hedge currency and interest rate risk at the fund level, and are also included in risk measurement. Our risk management system also uses a variety of stress scenarios that are continuously adjusted during periods of capital market stress to analyse potential changes in market price risk.
Collateral agreements associated with a loan are another source of risk and in some cases this risk can be unilaterally triggered by the borrower (e.g. if the borrower terminates the loan agreement). We already take measures to counteract this risk when assessing whether to invest in a loan by including any collateral agreements in the assessment. A Monte Carlo simulation is used to simulate future changes in capital market parameters, such as interest rates and spreads, and a migration matrix is also used to assess potential rating changes for the loans.
Risk assessment of loan funds
Similar to real estate funds of funds, sustainability risks are monitored using a scoring model developed specifically for this purpose that takes into account the special features of the assets financed by the loans. Physical and transitional risks for real estate loans are measured in a manner similar to real estate funds. With respect to infrastructure, the focus is on renewable energy loans. For ships and aircraft, attention is paid to satisfying the latest technical standards. Limits based on the type of loan are also used to help with risk measurement.