Funds count cost after market shake-out with H2O down 20%

Three weeks into the turmoil afflicting financial markets, the strain on funds is starting to show.

London-based H2O Asset Management has suffered one of the harshest blows. In volatile trading on Monday, its flagship Multibonds fund lost 20 per cent of its value on bad bets, according to data released on Wednesday.

The bonds and currency strategy has now lost 40 per cent since its peak last month, chopping back what was a €5.7bn fund just weeks ago to €3.5bn now.

In a letter on Tuesday, H2O informed investors of the “surprisingly large” losses. “We have experienced such crises in the past,” the asset manager said. “We know that the important thing is not to regret getting caught . . . but to manage the exit well.” 

Aside from the strain of the almost daily market ructions, asset managers are concerned that H2O is unlikely to be the last to report grim numbers in the coming weeks. Many are now steeling themselves for big outflows following the recent financial turbulence, which will test the industry’s resilience after a long bull run. 

“It is virtually impossible to identify the next domino to fall but one thing seems certain: They will continue to fall,” Scott Minerd, Guggenheim’s chief investment officer, said in a note to clients. Quoting Winston Churchill, he warned: “This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

Line chart of Index and share prices, in $ terms (rebased) showing Asset managers' resilience tested after long bull run

Global equities have now lost about 16 per cent of their value since the February peak, while government bonds have soared, pushing their yields down to record lows. Corporate debt has been pummeled, and several fund managers warn that his could prove to be the epicentre of any aftershocks.

This has unravelled what was initially a promising start to 2020 for asset managers. After robust inflows at the start of the year, equity funds suffered $42bn of withdrawals in the two weeks to March 4, while credit funds lost over $20bn, according to EPFR. Given that fund flows tend to lag behind returns, those numbers are expected to grow.

As a result, US asset management company stocks have tumbled by more than a quarter this year, comfortably putting them in bear market territory. In Europe, Amundi’s stock is down 20 per cent, Standard Life Aberdeen has dropped 21 per cent, and Schroders has lost 28 per cent of its value. Natixis, which owns H20, has fallen more than 40 per cent.

John Foley, the chief executive of M&G, argued some choppiness was inevitable. “If you are a pure-play mutual fund manager, life will be volatile with periods of inflow followed by periods of outflows,” he said. “The asset management business is somewhat challenged, but it’s not dead.”

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Others in the industry are worried about the wider ramifications that big outflows could have on markets that remain fragile. “One of the risks in turbulent market conditions is being forced to sell assets to meet liquidity needs,” UBS Global Wealth Management chief investment officer Mark Haefele said — a nod to the risk that drops in one market can almost automatically trigger drops elsewhere.

Some point to particular strain in corporate debt, which trades far less frequently than equities. That means it can be difficult to get trades done at times of turbulence and even modest selling can produce outsized declines, in turn worsening the sell-off and leading to further outflows.

This has been a concern since the financial crisis, and the corporate bond market has largely weathered every test of its resilience. When Third Avenue, a US money manager, had to freeze redemptions from its struggling junk bond fund in late 2015 it briefly caused mayhem, but the turbulence eventually passed.

Some fund managers said outflows had not yet forced them to sell underlying assets. “There will probably be days where we will see one-sided outflows but so far we have seen flows be relatively steady,” said John Yovanovic, global head of high yield at PineBridge. “We haven’t seen panic outflow days so far in credit.”

Still the recent poor performance of credit markets could prove to be a test. Investment-grade corporate bonds had until recently benefited from their greater safety. But an exchange-traded fund tracking the asset class lost 2.4 per cent on Monday, the biggest one-day drop since the financial crisis. An ETF that tracks lower-rated “junk” bonds has tumbled 8 per cent since the spreading coronavirus began to shake markets. Debt issued by US shale companies is of particular concern; already $110bn of energy bonds are distressed.

Craig Nicol, a Deutsche Bank strategist, argues it could even prove to be a “Minsky Moment” for junk bonds, a reference to the late economist Hyman Minsky’s theory that stability breeds complacency, and that eventually leads to a sudden crash. 

“Five years ago the high-yield market ‘only’ had falling commodity prices to deal with. This time round, liquidity is already a huge concern following the impact of the coronavirus selling,” Mr Nicol wrote in a report, warning that an “impending liquidity crisis” would be likely to cause losses on junk bonds to spiral higher.

Additional reporting by Siobhan Riding

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