The Challenge of Valuing Private Debt: A Look at H2O Asset Management

How to value private debt?

John Maynard Keynes, the renowned economist said “If you owe your bank a hundred pounds, you have a problem. But if you owe your bank a million pounds, it has.”

A few years ago, The Economist added “If you owe your bank a billion pounds, everybody has a problem”.

This nexus can be seen playing out between H2O an asset management company and Lars Windhorst a German financier.

In 2018, H2O’s funds were among Europe’s best-performing alternative funds, one strategy returned an impressive net 32.9%. Given the astounding returns, H2O’s assets under management increased ten-fold in six years from €3bn in 2013 to €30bn in 2019.

However, these returns and growth masked something deeper that was amiss. As per Financial Times, H2O held more than €1.4bn in bonds, issued by financial vehicles linked to Mr Windhorst across six of H2O’s funds.

These bonds are illiquid, and H2O’s funds are mandated to allow retail investors to withdraw their money daily. Matching short term obligations to long term repayments has always been a risky business. One particular investment, Sapinda Invest bond failed to pay its coupons on time.

Given the riskiness of the investment, in 2016, PWC, the auditor of H2O’s funds, issued a qualification relating to Sapinda Invest bond. The issue- the asset manager used a price contributed by an intermediary and the quotes received by the audit firm from other brokers were vastly different.

The discrepancy may have represented more than 1% of the net assets of one of H2O’s funds.

Moreover, the price reflected in the balance sheet did not factor in the illiquidity cost. The next year H2O removed the investment from the balance sheet. By rolling over the investment from Sapinda Invest bond into another one of bonds related to Mr Windhorst entities. In 2020, the French market regulator suspended a series of H2O funds because of their “significant exposure” to illiquid debt, Leading to an uncertain future for the retail investors who trusted H2O to protect their savings.

The point is, valuing private debt is subjective. It is possible to manufacture a win-win situation for the bond issuer and the asset manager while the retail investors are left in the dust waiting for their monies to be repaid.

Asia SGE can provide you with the guidance on dealing with such situations and transactions