Quarterly Commentary - Capital Markets Review
As a reminder to how quickly market perceptions can change, we reviewed our third quarter commentary from last year. What a difference 6 months can make! U.S. stocks produced their strongest start to a year since 1998 as investors gained confidence from a perceived “solution” to Europe’s debt troubles as well as continued strengthening of U.S. and global economies. In addition, stock markets around the world rallied for very similar reasons. The continued stimulus from central banks, together with the relative calm in the face of Greece’s debt default (let’s call it what it is) pushed investors into the proverbial “risk-on” trade that benefited small cap stocks and high yield bonds. As investors became more confident in the U.S. and global economies, growth stocks trumped value stocks in performance. In the U.S., among the large cap stocks, financials, information technology and consumer discretionary sectors led the way with telecom and energy stocks lagging. Globally, almost all major markets experienced the same type of exuberance as the U.S. with Japan and Germany leading the way among major markets and the UK and Spain lagging.
U.S. treasuries suffered the worst quarter in almost two years as investors piled into riskier assets and the underlying current of continued fiscal deficits sparked further flows into high yield and junk bond funds. Investors scaled back their holdings of low-yielding government debt, which was the safe haven of last year’s second and third quarters. Consistent with market action and our comments, European debt rallied strongly in the first quarter and high yield, lower credit fixed income rallied strongly across the globe. Emerging market debt performed well as investors liked the dual aspect of higher yields and solid fiscal and trade balances in select countries.
Hedge Fund Industry Review
Overall, broad hedge fund indices produced solid, yet unspectacular returns versus equities, as these diversified strategies had stronger relative returns in January and February and were relatively flat in March. The HFRX Equity Hedge Index returned 3.9%, a very solid return in a non-volatile, consistently upward market, considering that we believe macroeconomic issues remain key drivers in today’s market. Returns for event driven strategies and relative value strategies were also good as hedge fund managers took advantage of market inefficiencies and reasonable spreads in lower quality fixed income securities. Most macro strategies lagged as managed futures performed poorly.
Returns of long/short equity managers were quite good, in general, as many managers were able to adjust net exposures during the quarter as the markets continued to rebound on the heels of solid Q4 2011 performance. Despite maintaining lower net exposures, hedge funds were able to perform well as dispersion among equity security returns increased from the low levels seen in 2011. Equity managers appear prepared for sideways markets from here (consolidation) or a potential decline as issues in Europe, a slowdown in China and continued fiscal concerns in the U.S. could arise to the forefront quickly and cause a sell-off.
Fixed income strategies continue to be an area of strong relative performance versus investment grade government and corporate bonds and an area we believe where opportunities are robust enough to benefit from actively managed strategies. Certain strategies could also work well in a rising interest rate environment which isn’t necessarily around the corner, but could begin to occur in the next 12-24 months if the U.S. economy continues to grow at a slow pace and fiscal irresponsibility does not abate.
Our data gathering, analysis and discussions with underlying sub-advisers, leads us to believe that overall economic conditions are slowly improving in certain developed markets like the U.S. This could result in decent and probably better than expected earnings results for Q1 2012, which of course are announced throughout the early-mid part of the coming quarter. Risks are still prevalent and meaningful in regards to the European debt crisis, specifically Spain, and may continue to mute economic activity for this part of the world. Finally, while evidence suggests that the major developing economies of China, India and Brazil are slowing, we believe that the risk of hard landings in these countries is small, especially in the coming quarter.
In addition, we believe correlation among equity prices will remain low enough in order to provide a reasonable security selection environment and that, while volatility will increase some from the very low level of Q1, it will remain within an acceptable range overall, thereby allowing for moderate levels of net exposure.
The opportunity set in fixed income, specifically the areas outside of high-grade U.S. Corporates and U.S. Governments, remains positive. Balance sheets are in solid shape, cash flows are reasonable as economic activity has picked up, defaults should remain low for the foreseeable future, and spreads remain elevated, but are close to historical averages. Therefore, from a risk-adjusted basis, this remains a relatively attractive area for us.
The resulting asset allocation changes to Alpha will mirror our above thoughts, however, the degree of changes we instituted for Q2 are minor. We look to position the portfolio for a slight overweight to long/short equity and market neutral strategies, a solid overweight to relative value-long/short debt, underweight event driven and will maintain a neutral weighting to managed futures strategies.
As always, we value the confidence and trust you place in Hatteras Funds and the Hatteras Alternative Mutual Funds team in particular. We take our job as fiduciaries seriously and strive to exceed client service expectations. Please contact us with any comments, feedback and questions.
* The asset class and strategy return figures presented for the Hatteras Alpha Hedged Strategies Fund indicate how each strategy performed on a stand-alone basis and are not guaranteed as to accuracy. The strategies are part of an Underlying Fund Trust (“UFT”) structure. Individual investors may not invest directly in the UFT. The return figures are net of all underlying manager fees and expenses and UFT level fees. However, the strategy return figures do not reflect Hatteras Alpha Hedged Strategies Fund expenses, including fund administration fees, custody fees, fund accounting fees, etc., which would reduce the figures shown. Consequently, the information above was included for educational purposes only and should not be used to evaluate any Hatteras Alpha Hedged Strategies Fund performance. Past performance does not guarantee future results.
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 Funds 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 Funds, 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. 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.
IMPORTANT DISCLOSURES AND KEY RISK FACTORS
The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The summary prospectus and prospectus contain this and other important information about the investment company, and may be obtained by calling 1.877.569.2382 or visiting www.hatterasmutualfunds.com. Read it carefully before investing.
Key Risk Factors:
Certain hedging techniques and leverage employed in the management of the Fund may accelerate the velocity of possible losses. Short selling involves the risk of potentially unlimited increase in the market value of the security sold short, which could result in potentially unlimited loss for the Fund. Derivatives involve investment exposure that may exceed the original cost and a small investment in derivatives could have a large potential impact on the performance of the Fund. Options held in the Fund may be illiquid and the fund manager may have difficulty closing out a position. Fixed Income instruments are exposed to credit and interest rate risks. Investing in lower-rated (“high-yield”) debt securities involves special risks in addition to the risks associated with investments in higher-rated debt securities, including a high degree of credit risk and liquidity risk. The Fund may also invest in:
• smaller capitalized companies - subject to more abrupt or erratic market movements than larger, more established companies;
• foreign securities, which involve currency risk, different accounting standards and are subject to political instability;
• securities limited to resale to qualified institutional investors, which can affect their degree of liquidity;
• shares of other investment companies that invest in securities and styles similar to the Fund, resulting in a generally higher investment cost than from investing directly in the underlying shares of these funds.
The Fund intends to utilize these individual securities and hedging techniques in matched combinations that are designed to neutralize or offset the individual risks of employing these techniques separately. Some of these matched strategies include merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. There is no assurance that these strategies will protect against losses. The Fund is non-diversified and therefore may invest in the securities of fewer issuers than diversified funds at any one time; as a result, the gains and losses of a single security may have a greater impact on the Fund’s share price.
Because the Fund is a fund-of-funds, your cost of investing in the Fund will generally be higher than the cost of investing directly in the shares of the mutual funds in which it invests. By investing in the Fund, you will indirectly bear your share of any fees and expenses charged by the underlying funds, in addition to indirectly bearing the principal risks of the funds. Please refer to the summary prospectus or prospectus for more information about the Fund, including risks, fees and expenses.
While the Fund is a no-load fund, management fees and other expenses still apply. Mutual fund investing involves risk; loss of principal is possible. Please consult an investment professional for advice regarding your particular circumstances. An investment in the Fund may not be suitable for all investors.
Net Fund Operating Expenses are contractually capped at 3.99% for ALPHX and 2.99% for ALPIX through September 30, 2012, excluding dividends on short positions and interest on borrowing as well as other extraordinary items disclosed in the prospectus. Total Annual Fund Operating Expenses are 4.97% for ALPHX and 3.97% for ALPIX. Class I Shares of Alpha Hedged Strategies Fund were not in existence prior to September 30, 2011 and have a minimum investment of $1 million. Performance for any periods prior to the inception date of Class I, are based on the historical performance of the No Load Shares adjusted to assume the expenses associated with Class I Shares. Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Funds may be lower or higher than the performance quoted. To obtain performance information current to the most recent month-end, please call 866.388.6292 or visit www.hatterasfunds.com.
- Average annual total return
- Fund inception date: ALPHX 09/23/2002; ALPIX 09/30/2011, Since Inception performance for Class I is since 09/23/2002.
The Fund is distributed by Hatteras Capital Distributors, LLC, an affiliate of Hatteras Alternative Mutual Funds by virtue of common control or ownership.
(c) Hatteras Funds