The H2O problem

The last week or so has seen some disturbing developments at one fund management group and of course it comes hot on the heels of the problems of Woodford Funds that I looked at on the 7th of this month. There are some familiar features and themes in the two stories as we wonder if the synchronised timing is no coincidence. So let us take a look at the FT Alphaville article which opened the batting on this subject a week ago.

Proclaimed a “bond maven” by the Wall Street Journal, Bruno Crastes is the chief executive of H2O Asset Management — the firm he established at the start of the decade with backing from Natixis.

The Frenchman has been known to wholeheartedly embrace risk hoping to reap rewards in the longer term, with Mr Crastes perhaps most famous for his big bets on Greek bonds at the height of the eurozone sovereign debt crisis.

Being lauded as a “bond maven” by the WSJ, puts us on alert immediately. It is not quite as bad as being lauded as young business(wo)man of the year but still worrying enough. Then in an era where we often find it is the perceived safe havens are doing well someone who wholeheartedly embraces risk seems out of phase with the times.

There were also two other warning signs.

H2O has rapidly grown in the past six years: from managing €3bn in 2013, its assets under management have increased ten-fold to €30bn. It’s not hard to see why either, given that some of H2O’s funds were among Europe’s best-performing alternative funds last year. One strategy returned an impressive net 32.9 per cent.

If we start with the second sentence then there is a view that best-performers in finance should always be investigated because of the likelihood that this was caused by something outside the rules. After all 32.9% in these times of low interest-rates and yields?

The next point can swing both ways because who wants to broadcast a competitive advantage to the world rather than take advantage of it?

Mr Crastes has been reluctant to go into the specifics of how H2O has been able to beat the market so handily.

The Specific Problem

The mismatch below makes the funds look like a bank which is hardly reassuring as it does not have a central bank standing behind it.

Given that the bonds backing Mr Windhorst’s companies are highly illiquid, and H2O’s funds allow retail investors to withdraw their money on a daily basis, the apparent scale of these investments is significant.

Adding to the issue is the track record of Mr.Windhorst involving two company collapses and personal bankruptcy. But this was apparently no deterrent.

Using this methodology, H2O appears to hold more than €1.4bn in bonds issued by financial vehicles linked to Mr Windhorst across the six funds. They each hold exposures of between 5.5 per cent (Adagio) to 13.7 per cent (Multibonds) in Windhorst-related bonds.

The data suggest H2O is by far the biggest holder of many of Lars Windhorst’s bonds, often holding the majority of the outstanding amount across the firm and even individual funds holding up to 22 per cent of specific securities.

This was particularly pronounced here.

A bond issue from Chain Finance, a vehicle that Mr Windhorst used in 2017 to settle outstanding lawsuits and repay existing debts, proved a particularly popular investment for H2O. All six funds poured money into it, together they hold a combined €383m of the €500m bond — nearly 77 per cent.

H2O admit that this investment is illiquid and marked it down by 24% but there is more. The fund has been very keen on further investments in bonds issued by Mr.Windhorst.

And there are signs that newly minted bonds linked to the former “wunderkind” are now flowing into H2O’s portfolios.

Mr Windhorst appears to have been busily issuing new bonds in the past few months. There is, for instance, Netherlands-registered Trent Petroleum Finance, which issued a €850m bond in December last year…….In the past six months, Trent Petroleum, Rubin Robotics, Tennor Finance and Everest Medtech have issued a total of €2.75bn in bonds at yields between 5 and 8 per cent. And they are starting to appear in H2O’s filings.

As you can see we are continuing down the illiquidity route and seemingly making a virtue of it as we mull whether it has already become a trap where the fear is that it will all collapse if the music stops? This brings us back to the Woodfood Funds saga although this time around the investments are in bonds rather than equities.

I guess you are already on the case as to what happens next…..

Slip-Sliding Away

On Friday it seemed there was a case of trying to close the stable door after the horse had bolted. From Reuters.

London-based H2O, a key contributor of profits at Natixis Investment Managers, was put in the spotlight on Thursday when Morningstar flagged its review, citing questions over liquidity and governance at the H2O fund.

After all as a reply to the Alphaville article from FuturesRodney pointed out the situation had previously looked rather different.

Given the 5-Star fund rating from Morningstar, Trustnet and others, you have to wonder about the degree of analysis and true due diligence which these organisations apply?

Meanwhile according to Reuters the situation was indeed slip-sliding away.

Natixis said in a statement on Friday that H2O, which managed $32.5 billion in assets at the end of 2018, had seen outflows of 600 million euros (535.64 million pounds) between the start of the second quarter and June 20.

How much of that was after the Alphaville article?

Moving to yesterday we saw clear signs of trouble,trouble,trouble.

Around 1.4 billion euros (1.2 billion pounds) was pulled from H2O funds last week after rating company Morningstar put one of its funds under review, citing concerns over liquidity and governance. That sent Natixis shares tumbling. ( Reuters)

That makes me wonder how much was withdrawn on Friday and Monday as well? As for these purposes Friday was not part of last week.These situations can be like a dam bursting as so many try to escape through what is a small door at the same time. There has been a response.

H2O, which manages around 31 billion euros ($35 billion), said it had sold part of its non-rated private bonds. It did not give details, but said the aggregate value of the bonds represents less than 500 million euros as of Monday. (Reuters)

To whom and for how much are the obvious questions?

Anyway the dam analogy is in play as Robert Smith of the FT points out.

New data from H2O out: shows the assets across the six funds we flagged as having exposure to Lars Windhorst dropped €1.2bn on Friday; takes the total fall to more than €2.6bn


Also I doubt many of you will be surprised by this.

In a bid to stem investor outflows, H2O has also introduced “swing pricing”, imposing discounts on investors that want money back


This sort of crisis has happened before as there are echoes of the 1990s here as outperformance is followed be a reverse ( Long-Term Capital Management) and entry doors prove much larger than the exit one ( Milan Stock Exchange). But to my mind it is not a coincidence that we are seeing such problems.This is being driven by the developments below.

Bonds are winning, according to BofAML. Over the past 12 months:

– U.S. Treasuries outperformed the S&P 500 by 140 bps

– European bonds outperformed Eurostoxx 50 by 660 bps – JGBs outperformed Nikkei 225 by 840 bps

– EM sovereign bonds outperformed EM equities by 1250 bps ( @tracyalloway )

If we add in her calculation that there have been 715 interest-rate cuts in the credit crunch era we are left with the point that likely returns are dwindling. Also we return to the point I made earlier about safe havens and risk. No wonder some funds are heading for areas which are illiquid as they chase higher returns. But the catch comes to the issue of what is a fair price for these assets? The truth is that it is always opaque until somebody turns on the light and the cockroaches scatter.

The road gets darker as we note that the QE era has made this worse as it has made markets less liquid.In a explicit sense we see this with Japanese Government Bonds after all the purchases of the Bank of Japan,but it happened with Greek Government Bonds too.As an aside that is why I have a wry smile when Greek Government Bond yields are quoted.But there have been implicit effects too as many will not trade in German Government Bonds now due to this.


Also I think that we need to look at the roles of regulators such as the UK Financial Conduct Authority which has 2 problems on its books this month alone. To,my mind it needs to decide whether it has a basic role with investors needing mostly to observe a form of “caveat emptor” or whether its role is much wider than that? The latter role seems doomed to failure.

Finally are there wider fears or are the rallies in Gold ( US $1433) and Bitcoin ( US $11,398) just a coincidence?