H2O’s predicament should ring alarm bells on global liquidity
Asset managers claim they are not systemic but a larger scale fund run could show otherwise
“Absolute return doesn’t mean you’re up every day. It’s not possible.”
So said H2O Asset Management’s chief executive Bruno Crastes in an FT interview just four months ago. It proved a prescient comment. Last week, there were heavy withdrawals from several of its funds, after a series of articles in the Financial Times highlighted the firm’s exposure to highly illiquid bonds from companies connected to Lars Windhorst, the maverick German businessman with a history of legal troubles.
On Wednesday influential fund research group Morningstar withdrew its rating of H2O’s Allegro fund. By Thursday, the six funds the FT flagged as having exposure to Mr Windhorst’s businesses collectively saw more than €1.4bn of investor money withdrawn. Shares in H2O’s parent Natixis slumped 14 per cent.
Mr Crastes’ decision nine years ago to brand his firm H2O — because water is a pretty liquid substance and he boasted a decent record managing the liquidation of Amundi funds through the 2008 financial crisis — suddenly looks a little hubristic.
Earlier this month I wrote in this column that Neil Woodford was a canary in the coal mine. When instant-access investors in the star stockpicker’s Equity Income fund wanted to get their money out, Mr Woodford was forced to erect “gates” to prevent redemptions, due to large holdings of hard-to-sell unlisted stocks. Investors are still trapped in the fund and may be for a long time to come.
Now we have another canary.
While H2O has not put up the gates, insisting that “there is no question about the liquidity” of its funds, the cases have significant features in common.
Highly rated fund managers grow fast and invest in esoteric assets, designed to boost returns in an ultra-low interest rate environment. After a trigger, panic sets in about the quality of the fund manager’s underlying assets — small company equity holdings in Mr Woodford’s case; obscure bonds in H2O’s. Investors, who have instant access to their investments under Europe’s open-ended fund rules, rush for the exit.
Distrust is further stoked by apparent conflicts of interest. In Woodford’s case, the cosy relationship with fund distributor Hargreaves Lansdown has looked particularly ill-considered; at H2O Bruno Crastes sat on the advisory board of Mr Windhorst’s holding company, Tennor. (Mr Crastes stepped down on Friday, though only to be replaced by his chief investment officer.)
H2O’s problems appear less extreme than Woodford’s. It had up to €1.4bn invested in the controversial Windhorst-linked bonds — a significant amount. But relative to a €30bn portfolio, about 90 per cent of which is in liquid securities, such as government bonds, the danger does not yet look existential.
And on the conflict of interest point, Mr Crastes insists that the Tennor advisory board was set up at his insistence — with big names such as Standard Life Aberdeen’s Martin Gilbert brought on to it — precisely because the private companies needed close monitoring.
There will almost certainly be more trouble ahead, though. Even if investors’ distrust stabilises, there will be a further cycle of bad news. Official confirmation of investor withdrawals is likely to spook the market further. To keep regulators happy, H2O’s stock of illiquid bonds will no longer be valued on the basis of discounted cash flows but at market prices. In some cases, this may be closer to zero than face value.
Mr Crastes would argue that even a dramatic writedown of illiquid holdings would not hit the funds as hard as macroeconomic jolts: asset volatility is in the nature of an absolute return fund. And even if investors lose money, reversing years of outperformance, it is hardly of systemic concern if a €30bn H2O or a £10bn Woodford get into trouble.
Yet canaries they are, as was Swiss firm GAM last year amid its own liquidity crunch. Policymakers have begun warning that mass-appeal emerging market and high-yield bond funds may be the next victims of illiquidity.
The BlackRocks, Vanguards and Fidelitys of the world like to claim they are not systemic because they don’t carry the risk on their own balance sheets. Having trillions of dollars under management, including hundreds of billions across riskier asset classes, will feel pretty systemic to the world if the gas leak blows up the mine.