The "Draconian" market events of 2008, as Robert L. Worthington, president of Hatteras Funds describes them, "pushed financial advisors to ask for more products that offer diversification, safety and adequate returns-all in the same package."

Hatteras is now rising to the market changes, offering advisors a diversified package of alternative investments, Worthington says. Hatteras, based in Raleigh, N.C., is an alternative investment firm that began carving out its niche in the financial world before the bottom fell out of the market two years ago, but finds its offerings even more popular today.

The firm offers a range of alternative investment funds, designed to offer financial advisors and their clients easy access to institutional-quality private equity and hedge fund managers.  Its flagship product, the Hatteras Multi-Strategy Fund, combines hedge funds and private investment funds in one vehicle with the goal of providing greater returns and stability than these funds can provide separately.

Founded seven years ago, Hatteras launched this diversified offering with a focus on registered investment advisor firms, broker-dealers and the small to midsize institutional market. For this particular fund, Hatteras partnered with Morgan Creek Capital Management LLC, a registered investment advisor in Raleigh that provides investment management and advisory services based on the university endowment model. Together, they launched the first of the firm's multi-strategy funds in 2004.

"The advantage of investing in hedge funds is the low correlation to the S&P index and the corresponding decrease in volatility," Worthington says. "At the same time, we have built a diversified pool of private equity managers to seek return enhancement-all in the same fund. Combining the two in one vehicle is a very complicated process, so not many other asset managers can do this."

The Hatteras Multi-Strategy Fund uses 140 managers to allocate to six different asset classes: opportunistic equity, enhanced fixed income, absolute return, real estate, private equity and, energy and natural resources. The diversification provides lower correlation to the traditional asset classes of stocks, bonds and cash.

Hatteras offers endowment-style alternative investments to a client base of high-net-worth individuals, endowments, foundations and pensions whose investment sizes typically range from $1 million to $50 million.

As Hatteras was getting started, Mark W. Yusko, CEO and CIO of Morgan Creek Capital Management, asked about partnering with Hatteras to manage the multi-strategy funds.

"The world had 1,700 hedge funds of funds-I did not feel the world needed 1,701. So we said, let's build something different: a fund that does the whole job for alternative investments," Yusko says.

"Let's provide structure by offering the first registered alternatives and at the same time provide the financial advisor with the tools for instant diversification, without the investor having to hire 50 different managers," he says.

"We have specialists that provide different kinds of diversification-by investment, by time, by buying short or long," Yusko says. "For instance, we have global and domestic specialists, long and short investments in health care or technology, long and short in commodities and specialists in particular large-cap or small-cap investments and distressed credit.

"If we spend three weeks investigating a company and it turns out to be a bad company, we can buy it and sell short, using it to our advantage. For most other firms, they would have just wasted three weeks of their time investigating a bad company," he says.

"They always say, small fortunes come from concentration," Yusko says, "but large fortunes are built from small fortunes with diversification, which we can provide. We are opportunistic and have strategic targets for each asset class and we rebalance regularly. Other people eventually end up buying what they wish they would have bought, but by then it's too late. At Morgan Creek, we buy what we have faith in."

Universities and endowments have been doing this for 50 years, but only recently has this model become available to high-net-worth investors and institutions that are smaller than Harvard and Yale. However, many smaller investors are not able to build or maintain an investment portfolio that allocates significant positions to hedge funds or illiquid strategies and managers on their own.

Worthington adds, "We can provide the skill sets to combine investments that others do not put together in a single vehicle. It is another way of providing balanced diversification for high-net-worth investors."

Since Worthington joined Hatteras in 2007, the firm has launched other investment vehicles with a focus on hedge funds and private equity.

"Since 2008, everyone learned to look at the industry differently. Everyone with a retirement investment learned they need to be more careful to prevent their retirement from disappearing, and they need to better understand their liquidity needs," Worthington says. "Over the next decade, I believe Hatteras will allocate more to hedge funds, including private real estate, commodities and others, to create greater returns for the investor."

Following the initial multi-strategy fund launch in 2004, the firm began branding itself to offer additional joint ventures managed by Hatteras Capital Investment Management.

Among its newer offerings, Hatteras manages a global private equity fund of funds, a diversified fund of hedge fund strategies in a daily liquid, daily valued mutual fund structure, and a late-stage venture capital fund. Hatteras cannot comment on its private funds, but according to SEC filings, the global private equity fund offering is unique in its allocation.
About 40% of the fund will be dedicated to India and China, where the private equity market is growing rapidly (see sidebar). Only 25% of the allocation will be to the U.S.  For this offering, Hatteras partnered with Capvent, a private equity specialist based in Zurich, with three offices in India.

The dislocation of 2008 caused advisors and investors to search for liquidity even within the hedge fund space. Hatteras responded by purchasing ALPHX, a mutual fund that offers hedge fund strategies and hedge fund managers in a daily liquid format, from Alternative Investment Partners (AIP) in mid-2009. Hatteras officers believe the demand for liquid alternative funds will continue to grow and that this portion of Hatteras' business will grow in tandem with this trend.

"All of this came about because of a desire to offer high quality alternative investment products not usually offered by one asset manager to registered independent financial advisors, broker-dealers, wealth management firms, family offices and investment consultants," explains Worthington.

By building both the private equity and the hedge fund sides of the business, Hatteras has grown to manage $1.8 billion in assets, serving 7,000 investors through 225 different firms that are Hatteras clients. Hatteras has a 12-person investment team.

"We are continuing to grow," Worthington says, "and I think that validates that we have something unique to offer. Our funds are designed to reduce volatility. We seek to capture upside, but we focus on losing less than the standard indexes on the downside. Over time, that downside protection is what enables investors to protect capital and build wealth."

The combinations and flexibilities being provided are attractive to many advisors, as they seek to offer solutions to their high-net-worth and institutional clients.

Brian Jacobs, Hatteras' CEO, has another way of explaining the appeal. "Hedge funds today are sometimes considered more risky than they are. In fact, they were originally known as 'hedged' funds because they were supposed to hedge against market losses," Jacobs says. "So, a big part of our job is educating advisors to the fact that letting Hatteras handle their clients' portfolios using hedge funds and private investments-as a core alternative allocation-could reduce some of their risks.

"For the most part, you put money in a fund of hedge funds to reduce risk and into a fund of private equity funds to increase returns," Jacobs adds. Many advisors who turn to Hatteras have clients who want to live the rest of their lives comfortably, so they want returns with less risk. There won't always be enough time to recoup losses if they occur now. Hatteras has alternative investment funds registered with the SEC, which advisors like because of the frequency and transparency of financial reporting for those funds.

"Today, we are providing a combination of private equity and hedge funds, both combined and separately, in traditionally structured limited partnerships as well as mutual fund offerings. We created these access points to enable advisors to use alternative investments for all of their clients-larger clients, as well as those with fewer assets," Jacobs says.

Advisors Given Asian Private Equity Tour
Hatteras Funds views China and India as lands of opportunity in the private equity space-so much so that they took a group of eight advisors to those countries to see for themselves.

China and India are among the largest and fastest growing economies in the world and provide unprecedented opportunities for those seeking alternative investments, Hatteras believes.

"We traveled with the group to Mumbai and Bangalore in India and Beijing and Shanghai in China, holding meetings with various private equity firms, as well as the portfolio companies these firms invest in," says Hatteras Funds President Robert L. Worthington. "The advisors were able to ask questions directly to these private equity funds and companies to learn more about the specific industries in which private equity companies in China and India are currently investing."

This was the third international trip Hatteras has led during the last two years to give advisors inside access to the private equity companies the fund invests in, with the ultimate aim of offering a better understanding of the firm's overall investment process.

(For video coverage, click here.)

Hatteras has targeted 40% of a new global private equity fund for China and India, which have rapidly growing middle-class populations. As the middle class grows in these countries and demand for new goods and services increases, Hatteras feels new investment opportunities will continue to emerge in the consumer, retail, educational, financial services and infrastructure sectors.

"We want to capture the growth that private companies in these markets are experiencing," Worthington says. "We believe private companies in India and China present great investment opportunities in the coming years and expect some of these to become midsize to large companies over the long run.

"Our financial advisor clients rely on us to do the due diligence for them," he adds.

Hatteras also has found that the quality of the private equity funds in these countries has improved and are often run and managed by sophisticated investment professionals who studied and worked in the United States before returning to Asia.

"We will focus on small and midsize private equity funds that play an important role with their portfolio companies in providing expert management, corporate governance oversight and access to a growing pool of new talent," Worthington adds.

"This is not just about a financial investment, like it would be in the public market," he adds. "It is about private equity managers taking a sizable stake in the company to accelerate growth."