Interview with David C. Saunders of K2 Advisors

David Saunders has been involved in the investment and trading of financial instruments since 1983. He has worked at Tucker Anthony & R.L. Day as an equity trader; First Boston Corp. as Vice President on the equity block trading desk; WaterStreet Capital, a hedge fund, as Head Trader; Tiger Management, as Head Trader; WorldSec Securities as President and ABN Amro Inc. as a Senior Managing Director. He co-founded K2 Advisors in 1994. He graduated from the University of Maryland, College Park, in 1981 with a B.S. degree in Business. Your Franklin K2 Alternative Strategies Fund (SICAV) with close to USD 1 billion assets under management, is one of the fastest growing liquid alternatives funds. What is the fund’s investment strategy?
David Saunders: Building upon Franklin Templeton’s strategic acquisition of K2 in 2012, the Franklin K2 Alternative Strategies Fund provides access to a diversified portfolio of alternative investment strategies managed by institutional-quality hedge fund managers. It seeks to provide investors with lower correlations to traditional asset classes, reduced portfolio volatility and attractive risk-adjusted returns, while offering daily liquidity. We dynamically allocate assets across multiple managers and alternative strategies, including event driven, global macro, long short equity and relative value. We continually adjust the allocations to these strategies to reflect the team’s top-down market views with the goal of providing capital appreciation and lower volatility relative to the broad equity markets. How do you go about selecting the right managers for the fund?
Saunders: The total hedge fund universe consists of over 10,000 managers. Of these, 8–20 managers are approved for inclusion in the Franklin K2 Alternative Strategies Fund. The quality of these institutional managers is a key driver of value for the fund, and selecting and monitoring them requires experience, skill and significant resources. Our approach involves review by five independent teams, each performing due diligence on (and with the authority to veto) an individual manager. Potential managers are each screened by the Research, Portfolio Construction, Risk Management, Operational Due Diligence, and Legal and Compliance teams. This process is enhanced by proprietary systems designed for monitoring sources of return, portfolio exposures and risks. Do you think Liquid Alternatives – in Europe and in the U.S. – are the way forward for hedge fund solution providers to gain market share?
Saunders: Liquid alternatives offer daily liquidity, security-level transparency and fees that are typically lower than those associated with traditional hedge fund vehicles. Such liquidity, flexibility and transparency have persuaded a wider range of investors to use hedge strategies as a complement to more traditional portfolios. In addition, liquid alternatives can be distributed through retail channels, making them more accessible to the individual investor. What is your market outlook for 2016 and which hedge fund strategies will be most suited to thrive in that environment?
Saunders: Keyed by the divergence in growth prospects across regions and a decoupling of central bank policies, we expect equity markets to face continued volatility in 2016. A corresponding pickup in dispersion, which has historically been correlated with alpha generation, or excess manager return relative to the benchmark, could benefit long/short equity strategies.
Within corporate credit strategies, inefficiencies inherent in the non-agency residential and commercial mortgage-backed security markets will offer alpha trading and relative value opportunities, in our view.
For event-driven strategies, we expect the opportunity set to remain healthy in 2016 as many companies proactively pursue value-enhancing actions to avoid being targeted by activists. Companies have also been under pressure to meet earnings targets, and the slow growth environment could lead to further consolidation.
Finally, from a macro perspective, we are anticipating inflation will remain low globally in 2016, encouraging a liquidity environment that may benefit equities. In our view, global central banks are likely to maintain low short-term interest rates and continue record liquidity injections in select regions and countries outside the United States, such as the European Monetary Union and Japan, which could further cushion global economic expansion. With regard to the US Federal Reserve, the path for policy normalization could be lower for longer. Thank you for the interview.