FRANCE: H2O Suspensions Show Liquidity Risk Still Stalks Mutual Funds

Fitch Ratings stated that the suspension of redemptions by eight France-domiciled funds managed by H2O Asset Management on 28 August 2020 highlights that shortage of liquidity remains a key risk for mutual fund investors, particularly where funds invest in less-liquid securities.

The suspension of the funds, with combined assets under management of EUR10.1 billion at end-July 2020, increases the total value of European mutual funds that have suspended redemptions in 2020 to about EUR54 billion and the total number of funds to 117 (none of which is rated by Fitch). H2O’s other mutual funds remain open.

European mutual funds experienced a wave of redemption suspensions in March 2020, driven in all cases by valuation uncertainties. The H2O suspensions were also driven by valuation uncertainties, particularly in relation to private asset holdings. The suspension of three of the funds was ordered by the Autorite des Marches Financiers (AMF) to protect investors’ interests. H2O simultaneously chose to suspend a further five funds which had exposure to the funds subject to the AMF order. This highlights the risk of contagion to funds managed by the same investment manager and to financial markets more broadly. Similar issues involving hard-to-value private securities at Woodford Investment Management in 2019 led to multiple fund suspensions and liquidations. Before 2019, outflows were the main driver of mutual fund suspensions.

The H2O funds are the first France-domiciled mutual funds to suspend redemptions in 2020. French funds have access to a wide array of extraordinary liquidity management tools. “Side pocketing”, a new tool added by the AMF this year, involves separating less-liquid assets into a separate fund and transferring the liquid securities into new mutual funds in which investors can transact normally. Side pocketing is likely to be used to facilitate the re-opening of the H2O funds within a few weeks. This would provide an important test of the side-pocketing framework and mutual fund investors’ reaction to such mechanisms.