K2 Advisors became the latest fund of hedge funds to sell out to a much bigger rival, with a deal announced on Wednesday to sell a majority stake to Franklin Resources as investors' appetite for alternative assets continues to grow.
Current management of K2, which has been flirting with potential suitors for more than a year, will receive no up-front payment under terms of the deal, Franklin Resources said in a statement.
Franklin, which owns the world-renowned Templeton brand of international mutual funds and oversees $731 billion in assets, will be able to buy the remainder of K2 starting in 2016. The proceeds from the deal will let K2, named for the Himalayan mountain and founded in 1994, buy back a stake currently owned by TA Associates.
The deal comes at a time when fund of hedge funds have been under pressure following criticism they failed to provide proper due diligence when some firms invested with hedge fund managers who suffered heavy losses and then locked up investors' money during the financial crisis.
Some large investors, including state pension funds, are now trying to save money by cutting out funds of hedge funds. K2 and a handful of rivals were recently terminated by Massachusetts' pension fund as the state is now making its hedge fund investments directly.
Franklin will get access to the hedge funds K2 knows well and delivers on its promise to build out its alternative platform. The San Mateo, California-based company was founded 65 years ago and is still run by the founding Johnson family. The deal is expected to close in the fourth quarter, subject to regulatory approval.
While some asset managers may opt to build their own alternative units, Franklin has wanted to buy one for some time and met with some of K2's competitors, people familiar with the hedge fund firms said. Franklin has a taste for buying smaller, experienced, management companies. It took a 20 percent stake in Pelagos Capital Management two years ago.
"This new relationship with K2 is an important step in our overall plan to expand Franklin Templeton's alternative strategies and solutions platform," said Greg Johnson, chief executive of Franklin Templeton Investments.
Still alternatives will make up only a small portion -- roughly $20 billion of Franklin's $731 billion in total assets -- and will likely not offer a quick fix to more sluggish growth in traditional asset management, analysts have said.
For K2, which oversees $9.3 billion, the deal brings a strong corporate parent at a time many big investors are balking at fund of hedge funds' fees, making it tougher for them to raise money. Funds of hedge funds traditionally charge a 1 percent management fee and a 10 percent performance fee on top of the fees charged by the individual managers with whom they invest.
"This is a win/win for both K2 and Franklin Templeton," said Bradley Alford, chief investment officer of Alpha Capital Management. "The hedge fund-of-funds industry is going through a massive downsizing due to poor performance on top of very high fees, and Franklin immediately gets a firm with hedge fund expertise and a proven track record to address the coming demand from retail investors."
K2 was founded by William Douglass III and David Saunders and has built a strong reputation in the fiercely competitive hedge fund industry posting good returns and growing assets.
A recent report from consultants McKinsey & Co shows that retail alternatives, including hedge funds, will likely make up 13 percent of U.S. retail fund assets and one quarter of revenues, by 2015.
K2 is selling just months after Kohlberg Kravis Roberts bought fund-of-hedge-funds manager Prisma Capital Partners and Man Group acquired FRM Holdings.
More deals could be in the works, industry analysts say, as both mutual fund firms as well as private equity shops are eager to set up meetings with independent hedge fund firms like Pacific Alternative Asset Management Company, Rock Creek Group, Morgan Creek Capital Management, and Aetos Capital.
"Asset managers are increasingly interested in building out alternative capabilities and in some cases they are looking to acquisitions for that," said Gary Shub, who heads Boston Consulting Group's global asset management practice.
K2 has offices around the world and employs 115 people. Its
investment approach is not expected to change because of the deal, both firms said. More than a year ago, speculation mounted that K2 was getting ready to sell itself and talk that Carlyle Group was interested spread through the $2 trillion hedge fund industry.
© 2013 Thomson/Reuters. All rights reserved.