About a third of an H2O Asset Management fund was invested in illiquid bonds when the French regulator forced its suspension, more than three times higher than a regulatory limit on hard-to-sell assets.

In a rare intervention, France’s financial regulator last week asked H2O to suspend a series of its funds because of their exposure to illiquid debt, citing uncertainties over the valuation of these private bonds. 

The London-based subsidiary of French bank Natixis, which manages more than €20bn in assets, then brought down the shutters on four additional funds that typically offer retail investors the ability to withdraw their investment on a daily basis.

H2O is now shifting these assets into newly created funds, a process known as “sidepocketing”, which it says should take about four weeks.

H2O sent a letter to clients on Friday estimating how much of each fund’s assets it expects to place in these sidepockets, detailing the precise scale of their exposure to hard-to-sell bonds for the first time. 

The letter said its €3.5bn MultiBonds fund, its second-largest investment vehicle, managed by its chief executive and founder Bruno Crastes, will have 20 per cent to 30 per cent of its assets hived off. Its €887m Allegro fund, meanwhile, will have between 25 per cent and 35 per cent split out.

The move late last week by the AMF, the French market regulator, came more than a year after the Financial Times first revealed that H2O, which for years posted some of the most consistently high returns in European fund management, had substantial investments in hard-to-sell assets linked to Lars Windhorst, a financier with history of legal trouble.

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These illiquid assets became more problematic this year because several of H2O’s flagship funds lost more than 50 per cent of their value during the March turmoil triggered by the pandemic.

The collapse in the value of its funds made it harder for the asset manager to comply with EU rules governing open-ended funds, which place a 10 per cent cap on illiquid assets — known as the “trash ratio”.

The letter showed that the highest proportion of illiquid bonds it held directly in any of its funds was 9 per cent at the end of August. But some of its funds had as much as 25 per cent of additional exposures held as a result of so-called “buy and sell back” trades — where they took on additional bonds with an agreement to sell them back later.

The FT has previously reported how these trades meant H2O breached rules governing open-ended funds several times over the past year, racking up a series of infractions linked to its trading of Windhorst-linked bonds with certain counterparties.

While H2O struck a deal with Mr Windhorst at the end of April to buy back his businesses’ illiquid stocks and bonds, Friday’s letter said that “execution has been slowed down due to compliance requirements and due diligence”. These “operational delays” prompted the regulator to act, it added.

Via Financial Times