H2O AM, regulated in France and the UK, presents itself with “the objective of offering its clients the opportunity to achieve high risk-adjusted returns with daily liquidity”. Such an approach sometimes requires thinking outside the box. H2O AM recently played the Russia card to achieve this.
On 4 March, two international financial media, Bloomberg and the Financial Times (FT), reported that one of H2O AM's flagship funds, H2O Multibonds, had a 48% exposure to the rouble, via derivatives, on 31 January. Between mid-February and early March, the FT noted that the fund, which holds nearly €1.4bn in assets, had fallen by 28% as a result of the unprecedented sanctions that sent the rouble plummeting at the time, with 15% of that fall occurring on 1 March alone.
In a communication to its clients dated 3 March, H2O AM stated: “Our funds have recorded a net negative contribution over the past few days.” The asset manager explained that one of the main negative factors was related to “our forex and emerging bond strategies which include direct exposure to the Russian rouble”. H2O AM said that as of 3 March, the long exposure of its funds to the rouble did not exceed 7.5% of its overall gross currency exposure.
At the same time, H2O AM explained to its investors its intention to maintain its exposure to the rouble. “Historically, Forex channels have never been altered simultaneously and we do not anticipate this.” Furthermore, the asset manager pointed out that Russian exporting companies are forced to repatriate 80% of their profits. This would represent around $45bn every month, while the Russian population no longer has access to foreign currency, thus creating “an imbalance in favour of an appreciation of the rouble”.
Furthermore, H2O AM stated: “We consider that the sale of Russian assets should not be done at a deep discount, as this would benefit the buyers, including the Russian government, more than the shareholders.”
This strategy has finally been confirmed with the rouble having almost returned to its pre-crisis level.
The secondary market for Russian debt
While H2O AM indicated in its March 3 investor communication that it had reduced its exposure to Russian debt securities “because the new sanctions are affecting their liquidity”, the management company nevertheless decided to acquire Russian debt again, according to a March 31 communication. “At present, sanctions continue to affect the free price discovery of Russian assets in the offshore markets that international investors have access to. However, the liquidity of these assets is improving in international markets, as these same assets are trading at much higher prices in the onshore market, where local investors operate.”
As a result, the asset manager has been able to get its hands on local debt “at deep discounts”, but points out that the long exposure to the rouble and Russian debt in its funds as of 29 March is below the level prior to Russia's invasion of Ukraine. According information by Delano's sister publication Paperjam, H2O AM has a longstanding exposure to a basket of emerging currencies, including the rouble.
In a context of international sanctions against Russia, the strategy of H2O AM is surprising. However, H2O AM remains within the bounds of the law by limiting itself to intervening only in the secondary market for Russian debt and not in the primary market. The subtlety is significant, as the secondary market only trades debt that has already been issued. The primary market concerns the financing of the issuer itself. It should also be noted that the European sanctions do not apply to Russian sovereign debt issued before 9 March 2022.
Faced with the risk of being left with illiquid assets, the asset manager intends to control the liquidity of the rouble on the exchange. In terms of Russian debt acquisitions, these represent less than 2% of the net asset value (NAV) of its Global Macro mutual funds. The fact that Russian debt was acquired at a discounted price is also a factor in mitigating liquidity risk. A final element that reinforces the risk is that liquidity and prices are linked. If debt remains illiquid, then prices will not rise, thus limiting risk exposure.
No systemic risk, according to H2O AM
H2O AM justifies its approach to Russian assets by stating that “despite the violence and intensity of the conflict in Ukraine, neither the war nor the sanctions against Russia constitute a systemic risk for the financial markets”. The asset manager compares the impact on the markets to what happened at the time of Brexit and not to events such as the collapse of Lehman Brothers or the covid-19 pandemic.
Considering the war in Ukraine as “a localised crisis”, “the shock is symmetric in nature”. The asset manager explains that, initially, the shock is materialised by a sharp drop in assets directly, causing a rise in market volatility. At the same time, “a limited contagion effect” causes a decline in other risky assets peripheral to the crisis.
“The assets affected by the contagion are mechanically returning to normal levels thanks to the arrival of new opportunistic and unconstrained investors,” notes H2O AM. As for the assets directly impacted, “normalisation may take longer if their fundamentals have deteriorated”. Considering that “it would be very premature at this stage to talk about a deterioration of the fundamentals" of Russian assets, they should therefore continue their normalisation.
This story was first published in French on . It has been translated and edited for Delano.