H2O Asset Management, Bruno Crastes’ discretionary macro hedge fund firm, has written to investors to offer its “sincere apologies” for “significant” risk-adjusted losses this past week.
“If 2008 was a liquidity crisis, 2011, a volatility crisis, and 2016, a convexity crisis, 2020 is a combination of the three previous shocks,” H2O said in a client letter this week following the recent stock market collapse.
Its flagship fund H2O Adagio, which invests in sovereign bonds, credit and currencies, has shed more than 15 per cent since the start of the year, reversing last year’s 7.6 per cent annual gain.
Meanwhile, H2O Allegro, the absolute return strategy which trades sovereign debt, investment grade credit, high yield and currencies, has plummeted more than 54 per cent year-to-date, wiping out 2019’s 39.56 per cent annual gain.
The letter noted the violent swings experienced by the S&P 500 over the last three weeks, with the index moving more than 3 per cent in either direction a total of 12 times – “a frequency seen only in the Great Financial Crisis and the Great Depression.”
“No model could forecast and manage such repetitive shocks, and our earlier qualitative assessment of the crisis did not anticipate such an outcome. Also, our hedges did not work as expected, especially on currencies.”
Portfolio losses stemmed from a widening between long, risk-on trades – which comprise under-valued and volatile assets which sold off – and short, risk-off positioning, the more over-valued and less volatile assets which duly surged in value.
“For our global fixed income portfolios, the drop is roughly split equally between sovereign bonds and currencies,” the firm said.
H2O moved to reassure clients that in terms of flows, its funds’ net assets have proven “much more stable” than in 2019, adding its main objectives in the current environment are to cut risk “first and foremost”, but also maintain the “rebound capacity” of its funds once the crisis eases.
Adagio and Allegro were two of the six H20 funds that came under pressure last summer following concerns over certain illiquid bond positions.
“On behalf of the whole H2O team, we would first like to extend to you and to your clients our sincere apologies for our risk-adjusted losses which have been particularly significant since early last week,” the letter said, adding the recent “pronounced convexity” goes against the firm’s “value management style; it may however offer investment opportunities at a later stage.”
“It is too early to make any sound prediction of the end of the current sanitary/health crisis and its final impact on the global economy, but what we can ascertain is that even though the end of the tunnel is not visible yet, the lights have been turned on by central banks and governments,” the firm said, adding that markets may be underestimating the firepower of central banks globally.
As a result, H2O is now positioning away from assets not protected by central banks – such as US high yield and emerging market corporate credit – with the bulk of its exposure predominantly relating to G10 sovereign bonds and currencies instead.
“The reversion of these liquid instruments back to their fair value is in general faster than that of other assets.”
