A Simple Way into Alternatives

05/21/2012 7:30 am EST

Focus: ALTERNATIVE INVESTMENTS

Among Hatteras Funds’ investment vehicles are one that utilizes hedging strategies of several managers, while another gives investors exposure to a long/short equity strategy, as president Bob Worthington explains to MoneyShow.

Kate Stalter: I am speaking today with Bob Worthington, president of Hatteras Funds.

Bob, you specialize in alternative investment strategies. Maybe we could begin today by discussing the Alpha Hedged Strategy Fund (ALPHX), and what you’re incorporating in this particular vehicle.

Bob Worthington: Certainly, thank you for the time. In the Hatteras Alpha Hedged Strategy Fund, what we try to do is put together a diversified portfolio of hedged strategies.

So we are able to go out and find different hedge-fund managers and get them to run separate accounts within our mutual fund structure, putting together a multi-manager, multi-strategy portfolio that in many ways is just similar to the old fund-of-funds model in a partnership format, although we are able to do that in a daily valued, daily liquid, fully transparent mutual fund.

Kate Stalter: Are you seeking hedge-fund managers with widely diversified strategies? How does that work?

Bob Worthington: It depends on what we are trying to accomplish. So, out of the 21 hedge-fund managers in there, we have a few hedge-fund managers that would be considered kind of multi-strategy oriented, but the majority of the portfolio is full of the hedge-fund managers that have specific capabilities and focus on distinct strategies, such as long-short health care, for example, or convertible arbitrage as another example, or emerging-market debt.

What we are trying to do is find, for the most part, are managers that have specific areas of expertise within a well-defined area, and then put those together in a well-diversified portfolio.

Kate Stalter: As you know, Bob, a lot of retail investors, when they think about their investment portfolio, they focus on either equity or fixed income, more plain vanilla. How do you envision this fund being factored into an overall portfolio?

Bob Worthington: What we have seen in the last three or four years, with the growing advent of hedged mutual funds, are retail investors and their financial advisors utilizing these strategies in a much broader way, and throughout the portfolio.

So for the Alpha Hedged Strategies Fund, advisors and their clients have really used this in two different ways. You can use this as an equity substitute, because we believe over the long run we can give you equity-like returns, but with much lower standard deviation, volatility, and downside deviation.

Others use us as a fixed-income substitute, because they believe where we are in the investment cycle, that the returns for high-grade corporates and certainly government securities are going to be very low over the next five, six, or seven years. And they use this as a fixed-income substitute, really looking for greater returns than what you could get in a high-grade fixed-income portfolio, and yet the volatility is not that much different.

Kate Stalter: Is this something that investors can buy just directly through you, or through their broker, or do they need to go through an advisor?

Bob Worthington: They could do it a number of different ways. They can use a broker, they can use an advisor, and they could also come direct to us in many different ways. It is really what makes sense for how the individual or institutional investor invests, either on their own, or through the use of an advisor, a broker, or a consultant.

Kate Stalter: As you’re aware, one of the factors that has been critiqued about this fund has been a relatively high expense ratio—about 3.99%. What is your response to that?

Bob Worthington: The response that we give, and the response that is given to us by advisors or consultants that understand the fund-of-funds business, is actually the fees, the total fees on this versus a traditional hedge fund-of-funds portfolio, are actually very low. First of all, very competitive, and lower than what you would get in the old partnership days.

So, while 3.99% sounds expensive—we also have a share class for certain investors that is at 2.99%—that is actually less expensive than what most investors have paid. Even high-net-worth investors, or institutional investors have paid, when they go into partnerships.

The fees that were quoted there are actually all-inclusive of not only our fees, not only the administrative fees, which include legal and Blue Sky and audit and all those, but also the underlying hedge-fund manager fees too. So actually it is a very competitively priced, if not actually less expensive vehicle, than what people have had access to in the past.

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Kate Stalter: So it is just a matter of what kind of asset class you are comparing that to, and framing it in? Would that really be what you are saying?

Bob Worthington: Exactly. I think there are investors and consultants that want to use a hedge fund-of-funds; there are those that may not want to. But when you are looking to incorporate a fund-of-fund model into your asset allocation, then you should compare it against other fund-of-fund vehicles out there. That is, again, where we actually are very competitive, and less expensive than most.

Kate Stalter: Bob, we have a couple more minutes here. I wanted to also talk about the Hatteras Long/Short Equity Fund (HLSAX). Can you tell us a little bit about that?

Bob Worthington: Certainly. As opposed to being a multi-strategy, multi-manager fund, the Long/Short Equity Fund is actually a single strategy that focuses exclusively on long/short equity, but also is a multi-manager approach.

So currently right now, we have six underlying hedge-fund managers in the Long Short Equity Fund, soon to be seven within the next week. And then, what we are trying to do, again, is put together a diversified portfolio of hedge-fund managers that typically have a specific area of expertise.

And we think that is a very good way to manage exposure to long/short equity, because managers on their own can be somewhat volatile. If you put together six or seven that tend to have low correlation among each other, then you have a well-diversified portfolio, one that can mute volatility, versus straightforward equity managers. And yet, over the long run, if you pick the right ones, it can still deliver equity or equity-plus-like returns.

Kate Stalter: Where would this fit in a portfolio, versus, say, the Alpha Hedged Strategy? How would you recommend that these are differentiated?

Bob Worthington: Clearly in our mind, this is an equity substitute, for one.

And second, we believe, probably—and of course you can never predict future performance, nor can you say that this is going to happen in one quarter or even one year—but over the long run, a five- or ten-year period, you should probably see higher returns from a long/short equity fund than you would from a multi-manager multistrategy fund, because within the multi-strategy fund, i.e., the Alpha Fund, we have exposure to debt-type strategies.

So I think that is the differentiating feature and again, clearly, the Long/Short Equity Fund should be used as part of your distinct equity allocation.

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