Positive corporate earnings and an abating unemployment figure converged to create an equity rally that focused most of its optimism on this side of the Atlantic. The strong rally pushed the S&P 500 TR Index (the “S&P”) to a 12.6% return for the quarter. The Hatteras Core Alternatives Institutional Fund (the “Fund”) finished at 2.9% for the quarter, in line with its benchmark, the HFRX Global Hedge Index which finished up 3.1% for the same time period. Designed as a core alternative investment solution for all qualified clients, the Fund targets an allocation of 25% to private investments for potential return enhancement, and 75% to hedge fund strategies for potential risk mitigation. Our hedge fund strategy was positive 3.9% for the quarter due to success in the Opportunistic Equity strategy which appreciated 6.3% year-to-date. The private investment strategy was modestly positive at 0.2% because of muted activity in the IPO and M&A markets and a slowdown after the frenetic pace of distributions in 4Q 2011. Our belief is the hedge fund strategy will dampen macro induced volatility during the summer months as investors start “to sell in May (or even April) and go away” while private investment managers start running fast to capitalize on higher valuations in publicly traded capital markets and cash rich balance sheets.
Overall the performance of major hedge fund indices was positive in the first quarter and roughly flat for March. Equity and relative value oriented strategies did quite well and the more trading oriented areas such as managed futures, global macro and tactical trading strategies were flat to negative. The major separation between the first quarter and fourth quarter of last year was stock picking benefited greatly from lower equity correlations. We have also included Cambridge Private Equity’s preliminary benchmark from Q4 which was just released. See below for performance by hedge fund index:
Fund Strategy Overview
We are often asked about our macro views and themes percolating through our investment perspective. For the purposes of this letter, we would like to focus on the two basic ingredients of the Fund, hedge funds and private investments.
The Fund’s 74% allocation to hedge funds did well appreciating 3.9% whilst becoming more hedged as we progressed through the quarter. After a fair amount of allocation shifts to this strategy, we believe 2012 looks to be shaping up where Opportunistic Equity captures growth in areas like Emerging Markets and Technology while Tactical Trading and Absolute Return strategies diversify the overall portfolio should macro fears percolate back up. We also took the opportunity to lower our Enhanced Fixed Income strategy as we cycle out of mostly US focused distressed debt. The chart on the next page depicts the allocation shifts the Fund has taken over the last quarter and 12 months.
Lower equity correlations and a continued run in equity markets gave the Fund’s Opportunistic Equity strategy a much needed shot in the arm after a disappointing 2011. Working to incorporate a better risk/return profile has been a key initiative for the team and early success in Q1 seems to have delivered just that. Running the numbers to illustrate this is a rather simple but important illustration. Using the MSCI World Index as our equity benchmark, equities rallied to 11.6% in the first quarter. The Fund’s Opportunistic Equity Strategy began the year with 43% net exposure. In an up 11.6% quarter, a 43% net exposure should result in a net return of 5.0%. On a net basis, our strategy delivered 6.3% adding roughly 130 basis points on top of the 5.0%, generating significant alpha. While the total 6.3% represents 54% of the upside of global equities, we believe earning this type of return with its hedged positioning demonstrates a well-balanced risk return profile for not only the recent rally but positioning to buffer client portfolios from future volatility.
The Fund’s 26% allocation to Private Investments was quiet in the first quarter with a positive 0.2%. However, our take is that Private Investments are poised to play better offense than our hedge funds going forward pushing the Fund to be more hedged into the summer in the face of upcoming political uncertainty in China, France and the U.S. The performance of the strategy was muted as solid performance by domestic buyouts, venture capital, and domestic real estate were offset by weaker performance from international buyouts and diversified energy sub-strategies. We believe performance will strengthen through the year, as we have traditionally witnessed step-ups in valuations upon exits. While there was moderation in our manager exit activity in Q1 2012 compared to Q4 2011, we expect exit activity to increase in the next several quarters. We are aware of several sales processes which are underway, and which we believe could result in meaningful distributions to the Fund over the next several quarters. Given the continued maturity of the Fund’s private equity commitments, with 74% of commitments called and average portfolio company age of almost 3 years, our belief is that for 2012 and beyond distributions will continue to strengthen, with some seasonality (stronger in Q4 and Q2). In a market where public equities rally, we expect these private equity funds to seize exit opportunities, understanding that the process to sell a company takes time.
The first quarter of 2012 was light in terms of deal and exit activity for Private Investments contributing to the quarter’s flat performance. There were very few notable IPOs and the lowest amount of M&A activity in two and a half years. Going forward, we believe valuation changes will be driven more by public market comparisons and general increases in value as underlying portfolio companies progress through either a growth phase or restructuring process. The broader market’s recent slow pace and lack of M&A activity in comparison to the torrid nature of public markets is frustrating in the short term, but we believe represents a compelling value going forward as the private equity managers capitalize on exit opportunities in this cash rich and higher valuation environment.
A balanced position seems prudent given liquidity is slowing, credit spreads have tightened considerably and equity valuations have jumped. The destabilizing market force of deleveraging still exists and many economist have predicted that the coming months might produce some drawbacks in the markets like last summer, but also new entry points for growth areas such as Emerging Markets, Technology, Mortgage Backed Securities and possibly European distressed debt.
Future performance for the Fund is driven by successful execution of the two existing strategies, Private Investments and Hedge Funds. Private Investments were very quiet in Q1 but have a number of very interesting potential deals that we believe could be realized through the remainder of the year. The fact markets have already rallied so sharply leaves us a little impatient but actually makes the potency of this position all the more attractive and unique going forward. Current momentum in our hedge fund strategy is best highlighted by the single largest allocation in the entire Fund, Opportunistic Equity. It represents 34% making its hedged stance potentially accretive to client portfolios looking to take advantage of select pockets of growth while lowering their risk/return profile after such a sizable rally. If April’s volatility is a sign of renewed fear starting to percolate back up to global politicians and investors, then our blend of 74% hedge funds and 26% private investments looks to offer clients a way to stay invested in the markets, while keeping a skeptical eye on the continued deleveraging.
As always, we appreciate the confidence you have placed in Hatteras and your investment in the Hatteras Core Alternatives Fund. Thank you again, and if you have any questions please do not hesitate to contact us.
1. Annualized returns
2. Inception dates: Hatteras Core Alternatives Fund, L.P. and Hatteras Core Alternatives TEI Fund, L.P.: April 1, 2005. Hatteras Core Alternatives Institutional Fund, L.P.: January 1, 2007; Hatteras Core Alternatives TEI Institutional Fund, L.P: February 1, 2007.
Performance results and calculations after the Funds’ most recent fiscal year are unaudited. The principal value of the Funds will fluctuate so that an investor’s units, when redeemed, may be worth more or less than the original cost. Returns are net of all expenses of the Funds, including the management fee and incentive allocations, and reflect reinvestment of all distributions, if applicable. Returns do not reflect payment of the 5% redemption fee or upfront placement fees, which could be up to 2% if applicable, which would reduce the returns shown above. Past performancedoes not guarantee future results and current performance may be lower or higher than the figures shown. To obtain performance information current to the most recent month-end, please call 866.388.6292. The net expense ratio and total expense ratio for the Hatteras Core Alternatives Fund, L.P. are 2.32% and 6.52%, respectively. The net expense ratio and total expense ratio for the Hatteras Core Alternatives TEI Fund, L.P. are 2.39% and 6.59%, respectively. The net expense ratio and total expense ratio for the Hatteras Core Alternatives Institutional Fund, L.P. are 1.53% and 5.73%, respectively. The net expense ratio and total expense ratio for the Hatteras Core Alternatives TEI Institutional Fund, L.P. are 1.69% and 5.89%, respectively. The total expense ratio for all funds includes Acquired Fund Fees and Expenses of 4.20%. The Investment Manager has contractually agreed to waive fees and/or reimburse certain expenses until July 31, 2012 so that the total annual expenses will not exceed 2.35% for the Hatteras Core Alternatives Fund, L.P., and Hatteras Core Alternatives TEI Fund, L.P., and 1.75% for the Hatteras Core Alternatives Institutional Fund, L.P., and the Hatteras Core Alternatives TEI Institutional Fund, L.P. Please see the current prospectus for detailed information regarding expenses of the Funds.
Note: The portfolio analysis figures offer historical performance for each individual strategy as a composite of the Hatteras Core Alternatives Institutional Fund, L.P. actual underlying advisory funds. The historical performance shown indicates how each strategy (composite) performed on a stand-alone basis, net of all fees. However, none of the (composite) strategies shown are offered as stand-alone investments. This is not meant to predict or project results into the future, nor is it intended to portray performance of the Funds.
The opinions expressed in this report are subject to change without notice. This material has been prepared or is distributed solely for informational purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The opinions discussed in the letter are solely those of the Investment Manager and may contain certain forward-looking statements about the factors that may affect the performance of the Hatteras in the future. These statements are based on the Investment Manager’s predictions and expectations concerning certain future events and their expected impact on the Hatteras, such as performance of the economy as a whole and of specific industry sectors, changes in the levels of interest rates, the impact of developing world events, and other factors that may influence the future performance of the funds. Management believes these forward-looking statements to be reasonable, although they are inherently uncertain and difficult to predict. Actual events may cause adjustments in portfolio management strategies from those currently expected to be employed. It is intended solely for the use of the person to whom it is given and may not be reproduced or distributed to any other person. This should be read in conjunction with or preceded by a current prospectus. This material is not meant for general distribution. The information and statistics in this report are from sources believed to be reliable, but are not warranted by Hatteras to be accurate or complete. Past performance does not guarantee future results.
IMPORTANT DISCLOSURES AND KEY RISK FACTORS
This is not an offering to subscribe for units in any fund and is intended for informational purposes only. An offering can only be made by delivery of the Prospectus to “qualified clients” within the meaning of U.S. securities laws. Please carefully consider the investment objectives, risks, and charges and expenses of the Funds (as defined below) before investing. Please read the Prospectus carefully before investing as it contains important information on the investment objectives, composition, fees, charges and expenses, risks, suitability, and tax obligations of investing in the Funds. Copies of the Prospectus and performance data current to the most recent month-end may be obtained online at hatterasfunds.com or by contacting Hatteras at 866.388.6292. Past performance does not guarantee future results.
The Hatteras Core Alternatives Fund, L.P.; the Hatteras Core Alternatives TEI Fund, L.P; the Hatteras Core Alternatives Institutional Fund, L.P.; and the Hatteras Core Alternatives TEI Institutional Fund, L.P. (collectively referred to herein as the "Hatteras Core Alternatives Fund" or the "Fund") are Delaware limited partnerships that are registered under the Investment Company Act of 1940 (the "1940 Act"), as amended, as non-diversified, closed-end management investment companies whose units are registered under the Securities Act of 1933, as amended. The Hatteras Core Alternatives Fund is a fund of alternative investments. As such, the Fund invests in private hedge funds and private equity investments. Hedge funds are speculative investments and are not suitable for all investors, nor do they represent a complete investment program. A hedge fund can be described generally as a private and unregistered investment pool that accepts investors' money and employs hedging and arbitrage techniques using long and short positions, leverage and derivatives, and investments in many markets.
Key Risk Factors: The Fund invests substantially all of its assets in private equity investments that are generally not registered as investment companies under the 1940 Act and, therefore, the Fund does not have the benefit of various protections provided under the 1940 Act with respect to an investment in such private equity investments. Investments in the Fund involve a high degree of risk, including the complete loss of capital. The Fund provides limited liquidity, and units of the Fund are not transferable. General Risks, Special Risks and Investment-Related Risks of the Fund include, but are not limited to, Limited Operating History of the Fund, Limited Liquidity, Reporting Requirements, Non-Listed Status of Units, Non-Diversified Status, Legal, Tax and Regulatory Risks, Underlying Portfolio Funds Not Registered, Portfolio Funds Generally Non-Diversified, Valuation of Portfolio Funds, Multiple Levels of Fees and Expenses, Portfolio Fund Managers Invest Independently, Portfolio Fund Operations Not Transparent, Concentration of Investments, Derivative Instruments, Distressed Investments, Valuation of Illiquid Securities and Derivative Positions, Unspecified Investments, Leverage, Risks of Capital Call Failures, and Limited Selectivity of Investments. The success of the Fund is highly dependent on the financial and managerial expertise of its principals and key personnel of the Fund’s investment manager. Although the investment manager for the Fund expect to receive detailed information from each private equity investment on a regular basis regarding its valuation, investment performance, and strategy, in most cases the investment manager has little or no means of independently verifying this information. The underlying private equity investments are not required to provide transparency with respect to their respective investments. By investing in the private equity investments indirectly through the Fund, investors will be subject to a dual layer of fees, both at the Fund and the underlying private equity fund levels. Certain private equity investments will not provide final Schedule K-1s for any fiscal year before April 15th of the following year. Members should therefore expect to obtain extensions of the filing dates for their income tax returns at the federal, state, and local levels. Please see the PPM for a detailed discussion of the specific risks disclosed here and other important risks and considerations. The foregoing risk factors do not purport to be a complete list or explanation of the risks involved in an investment in the Fund. In addition, as the Fund’s portfolio develops and changes over time, an investment in the Fund may be subject to additional and different risk factors.
Securities offered through Hatteras Capital Distributors, LLC, member FINRA/SIPC. Hatteras Capital Distributors, LLC, is affiliated with Hatteras Capital Investment Management, LLC by virtue of common control/ownership.
(c) Hatteras Funds