Franklin Templeton’s K2 Athena Risk Premia UCITS Fund is a cross asset, alternative risk premia strategy. The fund has received The Hedge Fund Journal’s UCITS Hedge performance award for best risk-adjusted returns in the Alternative Risk Premia category for calendar year 2022. The strategy, which was originally domiciled in the Cayman Islands, has been live for over four years since the launch in July 2019. In common with most K2 strategies, Athena was seeded by clients. It was rolled into a UCITS in June 2021 with the same investment philosophy and management team.
Fund manager Paul Fraynt has been in the alternatives space since the 2000s in several sell-side and buy-side roles before settling at K2. “K2 provides operational economies of scale which allow us to lower costs, leverage the company’s regulation, legal and compliance support as well as risk management oversight and distribution,” says Fraynt. “In fact, at K2 we run a range of systematic quantitative strategies in comingled funds.” Since the firm’s founding in 1994, K2 has built up expertise in customization, managing a number of separate accounts for large clients.
We apply bottom-up portfolio construction to independent sources of alternative risk premia for each strategy, and build a market neutral, uncorrelated portfolio.
Paul Fraynt, Fund Manager
The philosophy behind K2 Athena is to isolate persistent uncorrelated sources of returns in a cost-effective, risk-aware approach. “We apply bottom-up portfolio construction to independent sources of alternative risk premia for each strategy, and build a market neutral, uncorrelated portfolio. The idea is to isolate a source of return that is fundamentally independent of the sources of return in all other strategies. Then the long-term correlation of returns in the fund should be close to zero over a multi-year period,” explains Fraynt. “However, there can be shorter-term cycles such as a strongly negative correlation with equities in 2022. However, long term the correlation matrix of the sub-strategies, and their betas, should be closer to zero,” he clarifies. “Although, given the intentionally defensive nature of the fund, we still expect to have a modest negative correlation to equities. After all, why would clients choose to pay heftier fees for more complex alternative solutions, if results were to be positively correlated with stocks?”
Athena uses a mix of academically well-known premia, often modestly modified with in-house built signals, and proprietary strategies that Fraynt believes are unique and may require more regular honing and refining. “We recognize that the source of returns for our proprietary strategies may not be as persistent as, for example, traditional value or momentum factors. Still, they are unique and offer vital diversification. They require more hands-on attention, and we are continuously working on research and development,” says Fraynt. For instance, Athena’s low beta strategy has been reviewed in light of higher interest rates due to an increasing negative drag in the new monetary regime.
In contrast to prior years, 2022 was a strong year for risk premia strategies. The macroeconomic climate for risk premia has improved markedly: “Risk premia strategies rely on long term cross-asset relationships. In a period of zero interest rate policy with no income, investors tend to go for growth. A long period of financial repression depressed returns, and flattened cross asset relationships, working against traditional risk premia. As ZIRP (Zero Interest Rate Policy) era came to an end, higher nominal interest rates helped cross asset relationships to revert,” said Fraynt.
Higher interest rates also directly flow through to returns via interest on both margin and unencumbered cash. This means that the entire fund earns interest on overnight Treasury bills, or other short term government bonds. In January 2023, this contributed 0.38%. Interest income now not only covers the fixed fees and costs of the fund but also contributes several percentage points of return per year.
The strategy, which was originally domiciled in the Cayman Islands, has been live for over four years since the launch in July 2019.
Though the tide may be turning in favour of systematic premia strategies, over the years there has been a wide performance dispersion between strategies that may sound superficially similar. The investment universe, choice of risk premia, approaches to portfolio construction, volatility targeting, implementation efficiencies, and timing factors are all important differentiators.
Athena currently harvests premia across equities, currencies and rates, mainly in developed markets (other K2 strategies cover other asset classes including commodities, insurance linked securities and even cryptocurrencies). Athena trades five broadly defined premia: value, momentum, carry, flows and low beta.
While strategies like value, carry and momentum are based on traditional academic research with a twist, Athena’s flows strategies are more unique and offer vital diversification from competitors.
While constituent strategies in Athena are meant to equally contribute to risk, and established protocols rebalance exposures systematically on a daily basis, the investment team infrequently aids with modest discretionary oversight.
“There is, however, a potential to occasionally exercise discretion to increase or decrease particular strategy weights if we observe regime shifts that cannot be captured by algorithms,” says Fraynt, who intervened in two of the sub-strategies in the second half of 2022 and again twice in 2023. “In 2022 we reduced trend weighting in October, when it became clear that the Fed would pause raising rates and simultaneously the ECB was becoming more hawkish. We also intervened in the flow strategy because zero-day option flows began interfering with established signals. We noticed an explosion of institutional and retail interest in very short-dated options in late 2022, which predated the ODTE (one day maturity options) phenomenon in 2023. Once trend signals rebalanced, effectively taking into account sudden changes in monetary policy, the investment team increased allocations to trend back up.”
Some systematic strategies target constant volatility, whereas Athena allows for fluctuation because constant volatility targeting would incur trading and transaction costs that Fraynt judges to be suboptimal.
Long term, the investment team does not expect Athena to have a substantial bias to any asset class, but in the short term, trend strategies can result in non-zero correlations to traditional asset classes. “Because the fund is constructed with a defensive bias, we expect on average to generate negative correlations to equities. And since inception of the UCITS fund, our weekly correlation to equities has been negative 40%. In many ways the fund acted as a quasi-hedge to stocks in 2022 when they were in retreat without incurring losses so far in 2023 when stocks have rallied,” says Fraynt.
Finally, the K2 team applies ESG screening to security selection, based partly on MSCI ESG ratings as well as on standard considerations in Australia and elsewhere.