(Bloomberg) -- Bruno Crastes wasn’t going to let a liquidity scare derail his $38 billion empire.
The star bond manager had seen the collapse of hedge fund LTCM. He had traded through the financial crisis and Europe’s sovereign debt crisis, emerging stronger from each. Now a fund freeze at famed U.K. stock picker Neil Woodford was putting a spotlight on firms seeking yield in hard-to-sell assets, including H2O Asset Management, the boutique he co-founded in 2010. Crastes took to video message to preempt such comparisons.
“We never gated, and we will never gate,” the chief executive officer said in the June 2019 recording, both hands gesturing as he leaned forward. After all, he had named his firm for the chemical name of water to underscore his commitment to liquidity.
A year-and-a-half after that show of confidence, the firm’s most illiquid holdings are stuck in side pockets at the request of regulators and Crastes, 55, is facing an uncertain future as his biggest backer is pulling out. The decision by Natixis SA to unwind its majority stake and end the relationship leaves H2O without access to the French bank’s vast distribution network, at a time when assets are already down by more than a third from early 2019 and confidence in some of the funds is shaken.
A spokesperson for H2O, which now manages about 20 billion euros ($24 billion), declined to comment.
Natixis had been key to the success of H2O from the beginning, providing operational support and access to investors, in addition to a financial investment that gave the French bank just over 50% of the firm. For much of the past decade, H2O was a jewel in the crown of Natixis’s stable of money managers, wowing an army of loyal clients with often stellar performance, at a time when negative interest rates starved savers elsewhere of returns.
Crastes had built a reputation at Credit Agricole SA’s asset management arm during the boom in alternative, absolute-return funds in the early 2000s that followed the dot-com bubble and crash. In April of 2005, he was rewarded with a promotion to chief executive officer of Credit Agricole Asset Management U.K.
Under Crastes and his predecessors, the division had somewhat of an arm’s-length relationship with its French parent, and alongside his CEO duties, he continued to run money. However, the boom times for Europe’s banks were coming to an end with the financial crisis, forcing many to cut costs and rein in the autonomy of star financiers like Crastes.
Read more about H2O’s troubles:
H2O Divorce Talks Begin as Natixis Pulls Decade-Long Support (3)
H2O Investors Pull $503 Million From Funds as Freeze Lifted (2)
H2O Freezes Eight Funds After Pressure From French Regulator
At H2O, a Changing Tide Tests Model Behind 20% Annual Returns
In 2010, Societe Generale SA and Credit Agricole merged their fund businesses to create Amundi SA, Europe’s largest asset manager. Crastes was promoted again, providing less time to focus on his main passion of making bets in financial markets, and the London outpost of the French lender lost some autonomy.
The same year, he left and set up H2O in an apartment he was renting in London’s Kensington district, a stone’s throw from the royal palace that Prince William, Duke of Cambridge, calls home. He linked up with an old Credit Agricole colleague: Pascal Voisin, who now ran the fund arm of Natixis.
Natixis took a stake in H2O and fellow Frenchmen including Chailley and Jean-Noel Alba followed Crastes out of Amundi to start the new venture. While Crastes and these deputies focused on making leveraged bets on currency swings and bond prices, Natixis would help handle the distribution and fund infrastructure.
For years, it was a perfect match -- and H2O set up shop in the hedge-fund haven of Mayfair. The firm produced remarkable returns and high performance fees for its owners, including Crastes, a resident of the tax haven of Monaco. By 2018, the firm was earning more than 400 million pounds ($526 million) in operating profit from revenues of just 517 million pounds.
A turning point came when Crastes was introduced by Chailley to Lars Windhorst about five years ago. A wunderkind of German finance in his 20s before going bankrupt, Windhorst relocated to London and started an investment empire based on issuing private bond placements rather than conventional bank financing. The H2O funds, previously focused mostly on foreign exchange contracts and government bonds, started buying Windhorst companies’ debt.
By 2019, H2O was one of the largest holders of bonds issued by Windhorst, with holdings of more than a billion euros. Yields on illiquid investments held increasing appeal in an ultra-low-interest rate environment, and also drew the attention of other prominent financiers.
Stock picker Neil Woodford, a star manager in Britain, had plowed large amounts into essentially illiquid equity investments -- unlisted or thinly traded companies. As performance waned and investors tried to pull money from Woodford, he couldn’t sell the illiquid securities to pay them back. Woodford was forced to freeze his funds to allow for an orderly liquidation.
Why Investors Are Spooked by ‘Liquidity Mismatch’: QuickTake
Morningstar Inc., examining H2O’s debt holdings, sounded the alarm following a Financial Times report that Crastes’s company faced similar risks. Panic ensued and investors pulled money, setting off a year-and-a-half of mostly bad headlines that ultimately led Natixis to throw in the towel.
Crastes took a different route than Woodford, having vowed not to gate his funds. He sold 300 million euros of bonds back to Windhorst’s firm at around 90 cents on the euro, according to a person familiar with the matter. The remainder of the illiquid securities were marked down to fire-sale prices, even though some of the assets traded at or near par around the same time.
The markdowns meant that fleeing investors had to take a hit, with the net asset value of the affected funds falling by between 3% and 7%. H2O said at the time that the markdowns were made in compliance with fund regulations and reflected “a valuation received by international banks.”
Though wounded by outflows, the firm still managed to produce stellar returns in 2019, with some of its funds ending the year up 40%. But the coronavirus stymied a lasting recovery -- halving the size of some H2O funds in March. That pushed the proportion of the illiquid Windhorst investments too high for the comfort of French regulators, who pressured H2O into freezing some of the funds for more than a month so that the hard-to-sell assets could be segregated.
When the funds reopened last month, investors pulled more than 400 million euros, mostly from H2O’s Adagio and MultiBonds funds. About 1.6 billion euros of investors’ cash is locked away in side pockets, according to data compiled by Bloomberg. While H2O has given investors shares in the less-liquid funds, they’re unable to redeem them while the money manager attempts to sell the underlying securities back to Windhorst.
For Natixis, what started as a brief scare has turned into a succession of damaging headlines that raised questions about its risk controls and oversight. On Thursday, the bank pulled the plug, announcing that H2O was no longer a “strategic asset” and that talks on a “progressive and orderly unwinding of their partnership” had started.
H2O said the talks include plans for it to take over distribution of its products and expand sales to independent financial advisers. The firm said it expects to make further announcements in due course regarding the impact on its business, “including its shareholding structure and changes to its governance approach.”
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