H2O warns clients of ‘surprisingly large’ losses after market turmoil

H2O Asset Management has sent a letter to clients warning that its funds face “surprisingly large” losses because of bets on bonds and currencies that turned sour during volatile market swings in recent days.

The London-based investment firm, a subsidiary of French bank Natixis, suffered €8bn of outflows from its funds last year after the Financial Times detailed the scale of its illiquid bond holdings linked to controversial financier Lars Windhorst. H2O had assets of about €30bn at the end of last year.

While the group met all of these redemptions, some of its funds blew through limits on counterparty risk when dealing with the fallout, while influential ratings group Morningstar downgraded one of its funds, citing H2O’s “loose risk controls”.

In a letter to clients dated March 9, H2O warned that its funds now face heavy losses because of a series of bets on the direction of bonds and currencies that went against them during recent market turmoil.

“This has led to negative performances that may be surprisingly large, but which do not correspond to our reading of the macroeconomic reality of today’s world,” the letter reads. “We have experienced such crises in the past. We know that the important thing is not to regret getting caught (almost impossible in the case of Covid-19), but to manage the exit well.”

H2O’s positions included a short trade on US Treasuries — which rallied to all-time low yields on Monday — and a long position in Italian sovereign bonds, which have been badly knocked as the country faces the world’s second-largest coronavirus outbreak after China.

H2O declined to comment.

Even before the market turmoil on Monday, the firm’s funds were sitting on large losses this year. H2O’s flagship €4.3bn Multibonds vehicle was down 25 per cent over the month through to Friday. Its returns are now negative for the past year, wiping out a 35 per cent gain investors who entered the fund in early March 2019 were previously sitting on.

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H2O’s funds have been some of the best-performing in Europe over the past decade, with Multibonds having regularly posted annual returns in excess of 30 per cent.

However Morningstar warned last year that H2O’s “stellar record” came at the “cost of higher risk than investors could have expected”, pointing to the “extensive use of leverage through derivatives”.

H2O’s latest investor letter flags that its funds have bounced back strongly from previous large losses during times of extreme volatility.

It says that H2O’s funds lost more than 20 per cent during the 2015 Greek government debt crisis, but that an investor who bought in at this point then made more than 76 per cent over the following three years.

At the height of the fallout over H2O’s illiquid debt exposures last year, chief executive Bruno Crastes vowed to never halt redemptions from its funds, which mostly allow investors to withdraw their money on a daily basis.

Worries about H2O’s performance have fed through to the share price of its parent company Natixis, which was the worst-performing major European bank on Monday, as the asset management subsidiary has been a key source of profits for the French lender. Natixis shares fell 18 per cent on Monday and were down a further 2.5 per cent on Tuesday.

Matthew Clark, an equity analyst at Mediobanca, slashed his price target for Natixis shares on Tuesday, citing the impact of H2O’s weaker performance on the bank’s revenue. He also flagged the potential for renewed concerns around the fund manager’s hard-to-sell bonds.

“Against a backdrop of stressed markets, we fear reputational risks relating to these illiquid fund holdings which weighed last year could yet resurface,” Mr Clark said.

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