Franklin Templeton extends hedge industry consolidation trend with K2 purchase

US mutual fund giant Franklin Templeton is branching further into alternatives investing by buying a majority stake in K2 Advisors, in another high profile example of consolidation of the fund of hedge funds industry.

K2 will use the cash to pay off all its debt and the equity stake in its business currently held by private equity investor TA Associates.

Franklin Templeton said the strategic move, which is expected to complete by the end of this year, would enhance its alternative investments and multi-asset solutions platforms. It will then buy the remaining stake in the alternative investor, starting in 2016.

The move by the $731bn Franklin Templeton group follows on the heels of similar buy-ups of hedge fund allocators such as FRM, by Man Group, announced earlier this year.

Funds of hedge funds have found themselves under increasing pressure as institutional investors bypass them to invest directly in hedge funds instead, and sometimes baulk at paying a second layer of fees.

Funds of funds have also had a mixed record of picking above-average hedge funds, according to performance data from Hedge Fund Research. Their own average annual returns, compared to the average hedge fund’s, suggests the allocators have failed to identify better-performers in six of the last eight calendar years.

Admittedly, the number of funds of funds has grown from 291 when K2 began in 1994, to 1932 in June, but the industry has contracted steadily in number since 2007, when there were 2462 funds of hedge funds.

Annual flows from funds of funds have been more eratic since 2007, but outflows occured each calendar year, depleting this allocator community from $798.6bn in 2007, to $626.7bn by June. Over the same period, hedge funds lost business in only two years (2008/2009), and have grown assets overall from $1.86trn in 2007, to $2.1trn now.

The $9.3bn K2 firm has as much pedigree in hedge fund investing as rivals FRM and Man – if not the size of assets – as its life extends back to 1994, when it was co-founded by William Douglass and David Saunders.

Douglass and Saunders have entered what Franklin Templeton calls “long-term employment arrangements”, and they will continue to manage the business. K2’s management will not sell any of its interests “at this time”, according to material accompanying the M&A announcement today.

The K2 management also will not receive an up-front consideration in the transaction, which was for an unnamed amount.

Greg Johnson, CEO of Franklin Templeton Investments, said: “One of the ways that we have built Franklin Templeton’s global business is by making strategic investments in smaller, highly experienced asset management companies whose expertise complements Franklin Templeton’s global offerings and meets our world-class standards.”

Johnson also presaged further expansion of Franklin Templeton’s alternatives activities: “This new relationship with K2 is an important step in our overall plan to expand Franklin Templeton’s alternative strategies and solutions platform.”

William Yun (pictured), executive vice president, Franklin Templeton Alternative Strategies, said: “The continued development of our alternatives platform has been a core strategic initiative for Franklin Templeton, and to that end we’ve focused on creating new investment strategies and broadening our distribution capabilities across multiple channels.”

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