Bruno Crastes is a man obsessed with liquidity, so much so that he named his own company after it.
A top fund manager and fixed income specialist for over 20 years, Crastes launched H20 Asset Management in the summer of 2010 to much fanfare. The new boutique, he said, would put liquidity and transparency – ‘the most important features of successful fund management,’ – at the heart of its investment process.
But fast forward 18 months and things are looking a little less rosy. His flagship MultiBonds fund had a tough 2011, losing 8% and underperforming its stated benchmark, the JPM Government Bond Index Broad by 18%.
CRASTES' PERFORMANCE HAS DROPPED LATELY...
Since inception the fund is down around 5% while the benchmark is up by just over 5%, so again some significant underperformance. If we look too at the performance of his long-time colleague Vincent Chailley we get the same story. H20 Patrimoine, a global macro fund, was down by almost 30% by the end of 2011 compared to a rise of 4.8% from its composite benchmark.
...BUT HIS PREVIOUS FUND'S RECORD IS STRONG
2011 was clearly tough on them. So where did they go wrong? Ironically, much can be attributed to liquidity. While the bank note printing presses in the US were going full tilt for much of the year, in Europe, politicians were slow to take action.
‘Unfortunately up until the decision to go for the LTRO, the liquidity in Europe was not sufficient to counterbalance the tail risk related to Greece and European peripheral markets,’ explains Crastes.
As a holder of Greek debt, this hit him especially hard. ‘When you owned Greek debt, it was very difficult to perform in 2011, and you didn’t need to have a lot. ‘We had some convictions in the way in which Europe would sort out its problems. Essentially we underestimated the political issues and their impact on financial markets, most of our underperformance
can be explained by that fact.’
Turning point for EuropeHowever, with the ECB’s second tranche of LTRO cash imminent as I write, Crastes is hopeful that Europe has now turned a corner.
‘Markets want deeds and definitely the LTRO is a game changer’. The big lesson he says from the ECB’s injection is that the market is even more sensitive to liquidity than it is to tail risk.
‘What we saw last year was massive tail risk in Europe and massive underperformance of European risky assets. That will not be the case this year thanks to better liquidity in Europe and globally within the banking system.’
But despite the ECB’s positive move, risky assets, he says are still cheap. A few too many tripwires down the line explain that.
‘We still have a lot of uncertainties; the Greek bailout, the strengthening of the ESM and the EFSF, the role of the IMF and its commitment to Europe – all of these are question marks but the market can live with these uncertainties as long as the liquidity does not dry up.’
If these issues are resolved, Crastes says he can see risky assets performing well this year.
Nowhere to diversifyBut back to 2011. On top of his European exposure, correlation also compounded Crastes’ problems, with bi-polar markets proving to be the enemy of his ultra diversified approach.
‘What happened in 2011 was that everything was very correlated within risk-on or risk-off environments, diversification was very scarce, this is a situation that is difficult for global value investment processes like ours.
‘Our investment process is based on diversification and unfortunately there was no way to diversify from
what happened in Europe.
His attempts to diversify a long position in peripheral markets by shorting the euro, were thwarted, as the currency remained stubbornly strong up until very close to the end of 2011.
‘We did try to find some hedges, shorting some risk-on currencies like commodity currencies, buying some bunds or treasuries,’ but much of it proved to no avail.
But he’s not too downcast as he points out that he’s been here before. ‘It happened to us in the past. We had other periods like this such as in ’94, ’98 and from mid-2007 to mid-2008 but they have always been great opportunities for our clients.’
Currency conundrumAnother issue which he says he is finding frustrating is owning currencies amidst a global currency war. Even for seasoned pros such as Crastes, it’s proving to be challenging.
He says there are now three distinctly different types: those that are in debasing mode – the US dollar and sterling; the slow, weak growth currencies like the euro; and the high yielding emerging currencies which have a lot of growth and no big deficits but come with a hefty price tag.
‘So there are no single real currency investment opportunities,’ he says.
Clearly none of the three options on offer appeal. Perhaps the reason for this can be found in another tenet of H20’s investment process, the idea of ‘stable risk-adjusted alpha’.
Back in March in an interview with Citywire Crastes said that fund managers who try to create alpha through market calls alone are generating ‘very unstable performance and low quality alpha’.
Stable performance, he said, comes from the quality of the diversification and the quality of the portfolio
construction. Diversification, he argued ‘is a massive engine of performance’.
In a highly correlated market though, that engine backfires making it particularly tricky to avoid the dreaded low quality alpha.
‘When there is a lot of turmoil the worst assets for the long term tend to be the best for the short term,’
‘That’s the big problem now with AAA bonds, bunds or treasuries, they are perhaps good assets in the short term because they offer good diversification to risky assets, but on a long-term basis they are the worst.’
He highlights that he’s been long treasuries as a hedge against his European position but has now
reduced that as he doesn’t believe in the asset class for the longer term.
‘Printing money reassures investors because it erases fixed income tail risk, satisfies greed and fear, but over the long term it could be disastrous.’
A more positive overview
So what to make of it all? It seems focusing on the specifics of Crastes’ portfolio may be slightly missing the point as this is a fund which is much more about the layering, it’s about how all the
various elements fit and work together, it’s about the overall ‘combination’ as he puts it.
‘The key element for the success of our investment process is the quality of the combination of our assets, not to look at what we do asset by asset.
‘When there is value in combining assets we tend to perform very well.’
Investors, he says, have reacted with understanding to the underperformance: ‘I think they have faith in our investment style and know that we are recovering.’
In the end it comes down to investment horizon. This is a young fund operating for much of its short life in a market in which it is deeply unsuited – investors are no doubt all too aware of this and are holding firm until the market turns.
After all Crastes is by no means having a crisis of confidence. ‘It was not a difficult year last year, it really wasn’t. It was only difficult if you had some positions in Europe.’
He’s not dwelling on the Greek bonds that cost him either: ‘We have already recovered two thirds of the 2011 underperformance and we expect much more in the coming months. This crisis will create value for our investors the way it did in past instances.’
Things, it seems, are looking up.
French selector Florian Greffeuille of ABN Amro Advisors has been tracking Bruno Crastes’ venture for some time. However, he has been put off from investing by a number of factors as he explains: ‘Crastes was over optimistic about the euro crises resolution and Greece in particular. The volatility of the fund, the drawdown and the risk control remains a matter of concern for me.’
This article originally appeared in the March 2012 edition of Citywire Global magazine.