Since Hatteras Funds acquired the Alpha Hedged Strategies Fund in 2009 from AIP Mutual Funds, the fund family has grown to $700 million in assets under management. The investment firm promotes the Alpha Hedged fund as a "core alternative investment solution for hedge fund strategies," with multiple hedge fund strategies and hedge fund managers.

Robert Worthington has been president of the boutique, alternative Hatteras Funds in Raleigh, NC, since 2007. Starting last month, Worthington is taking part in Meet-the-Managers forums being held in five cities across the country in conjunction with the anniversary of the fund. Money Management Executive recently spoke with Worthington about the fund's investment process and why he thinks alternative funds are here to stay for the long term.

What is the correlation between this fund and the overall markets? In particular, how did the fund perform during 2008?

The correlation to the market is about .77 since we took the fund over. In other words, the fund moves up or down by .77 in contrast to whatever value (whole number) the S&P moves by. This is the benefit of an alternative fund like this; it provides some cushion when the market goes down as it doesn't decline as much.

We don't look at correlation in terms of measurement and diversification and downside protection; we look at positions and how we manage the portfolio on a beta basis. For the last three years, it's been a .27 beta, so it's a very low, beta-oriented portfolio. To us, that's a better measurement of potential diversification and downside protection.

In 2008 the fund was down 32%, but we did not manage the fund at that time. [Alternarive Investment Partners] had put a leverage on it and their asset allocation framework was somewhat lacking.

The fund underperformed in the second quarter due to a long/short equity strategy. What steps did you take to remedy that?

We haven't done a lot to remedy that because we're comfortable with our strategy allocation, although we have brought down our exposure to long/short equity a little and raised it to long/short debt. We've also increased, for defensive purposes, our position in managed futures.

What is your manager selection process like? How do you hire and fire hedge funds?

We have a very detailed and long-standing process that starts with manager sourcing. We probably talk with a good 300 to 400 hedge fund managers per year. It's up to the team to funnel through what they think are true hedge fund managers or managers that might have an edge. From there we go to our second level of due diligence and get more senior people involved.

At that point we'll take a look at detailed risk measurement types of statistics, as well as risk management processes and information systems they have in place. The process is also driven partly by where we think there's a good fit in the portfolio. Next, the firm is discussed in the investment committee and typically we go back to a company a third time. Then we present it to the committee for approval or decline.

Firing can take place due to a number of factors. These include a manager's performance, our finding a better manager, a manager's strategy having run its course, key people leaving a manager, or a manager changing its stripes, such as adding little nuances which we believe are not within their realm of capabilities.

What is the turnover rate regarding the fund managers?

Outside the first year and a half after we took the fund over, turnover rate is about 15-20%.

Hatteras has said that the fund family "offers multi-strategy, multi-manager, daily liquid alternative mutual funds, providing position-level transparency and allows investors to increase their allocation to alternatives without compromising liquidity."

One of the problems in the past that some people have had, whether it's large, medium or small institutions, is that there was probably a limit to where they could put money into alternatives. A lot of the reason was related to the illiquidity features of traditional partnerships. As everyone learned in 2008, liquidity does matter.

It used to be that you might have been limited in your use of hedge funds or fund of funds because you didn't want to go above 15% of your total assets for liquidity reasons. Today, with the advent of liquid mutual funds, you don't have to worry as much about illiquidity. If we can offer something that is daily valued, daily liquid, and the underlying investor knows we have full transparency, that allows us to aggregate risk factors and exposures so we know where our portfolio is exposed. I think that gives people more comfort.

You also said there's a demand for alternative investments among advisors today. Do you see this continuing?

The long-term trend seems to be intact; advisors will increase their use of hedge fund strategies. In the last few years we've had a great rebound in the equity markets. The Fed and the European Central Bank and other central banks have been very accommodating and will continue to do so. Hedge fund returns have not kept up with the market, so there might be a short-term tactical slowdown, but I still see the long-term trend intact in vehicles like ours.

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