Kate Stalter's  Instablog

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 Worthingtonexplains 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.

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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Advisor Jesse Anderson explains his firm's strategy for identifying ETFs with efficient options markets, thereby capitalizing on inherent volatility. He discusses one of the firm's core ETF positions, and a sector ETF he likes right now.

Kate Stalter: Today, I'm on the phone with Jesse Anderson. He's the chief investment officer at Snider Advisors.

Jesse, I had heard some interesting, intriguing things about the Snider method, and I wanted to get in touch with you and hear a little bit more about that. Can you begin today by just setting the stage for us, and telling us what the Snider method is and what the history of that is?

Jesse Anderson: Sure, thanks Kate. The Snider method is a long-term investment strategy, and we use both stocks and a big piece of it is covered calls as well, kind of using cash management in order to generate income. And that's probably one of the things that sets the Snider method apart from a lot of other, let's say, stock market strategies, is our focus on cash flow and income generation.

We started out looking at ways to use your portfolio to replace income, specifically when you look at retirees, because we're all aware of the wave of baby boomers that are about to retire. And in the past they had pensions to go out and support their lifestyle once they retired, but these days that's kind of nonexistent. So they're having to rely on their 401(k)s, and that's where we have generated an investment strategy to really focus on that, and turn their 401(k)s and their portfolios into a monthly paycheck.

• Also read: http://www.moneyshow.com/video/VideoNetwork/100/8073/Earn-Safe-Steady-Income-from-Options/

Kate Stalter: And you use separately managed accounts?

Jesse Anderson: Yeah, when we manage accounts, we actually look at each account and allocate it specific to that account's perimeters, based off the size. So each account is individually handled. We won't look at two accounts and they'll be exactly alike.

That's really due to the kind of options that are involved in our strategy when we go out and trade an account for the first time. And then ongoing, we look at the market, and what's out there, and the volatility and the stocks or the positions that we're going to use. And that constantly changes throughout the day, and ongoing.

So really, you could look at all the accounts we manage, and it's very unlikely that any two are exactly alike.

Kate Stalter: So is there regular trading in these accounts, or is it a longer-term hold strategy, or maybe some kind of mix of both?

Jesse Anderson: I'd say it's a good mix of both. Any time we take a position we're really expecting to, or are confident in, taking kind of a long-term position in it.

But what does happen is-and we do, let's say, trade or rebalance these accounts on a monthly basis-because the use of our covered calls, we always use the front month. So they expire only 30 days out, and we really look to take advantage of the time decay; that is the highest in that time period.

So each month we go in, and we look at the positions out there. And we either kind of continue with the positions that we currently own, or go out and buy into some new or additional positions.

But it really is kind of a monthly trading process, but there are times where we'll hold a position over many years; other ones might just last, you know, one month. It really depends on how the position goes, but we're always, we look at it as it's a long term commitment.

Kate Stalter: When you're talking about rebalancing on some kind of monthly basis, that does sound like there is a technical or chart component to that. Would that be the case?

Jesse Anderson: No, I wouldn't say there's any technical-another factor that we really use is dollar-cost averaging. So we won't go out and commit all of our money into a position right away. We can look, see how the position works over the course of the month or long term and if we can add money to the position over the course of multiple months.

A big part of our accounts are in cash, and that's cash that is allocated to the positions open in the account. And we'll put it to work if necessary. But if we're able to generate that income with less equity involved, we'll do that. But we'll add to the position.

Definitely no technical factors-more dollar-cost averaging in new positions.

• Also read: http://www.moneyshow.com/trading/article/40/OptionsIdea-27611/2-Iron-Condors-But-One-Is-Safer/

Kate Stalter: Let's shift gears. We had been communicating by e-mail about some of your ETF strategy as that applies to your methodology. Tell us about that, Jesse.

Jesse Anderson: Yeah, it's something we just introduced. We're all very pleased with the strategy.

What we found is: People had a little bit of higher concern holding individual stocks. And with the evolution and the introduction of ETFs, what we are able to do these days is basically work our same kind of Snider Investment Method strategy on ETFs.

One of the big things we do is: Have one position, typically kind of a broader market index. One of the ones we're using these days is the Russell 2000 Index ETF (IWM), but we go out and use that as kind of a larger position. We place those same kind of covered calls on that position, and then beyond that we have some smaller ETFs, but they're a little more volatile.

And you know, in our case, in covered call terminology, when you have volatile, that means more income for us. And so we go in and again, use the same strategy to some of these smaller positions. But typically, we hold one big position in more of a broad market index. They will generate a piece of our income, and kind of manage the bulk of our exposure to the market.

Kate Stalter: I want to follow up on that. It's interesting that you're using the Russell 2000 ETF as a core. Because what I hear a lot is, advisors being conservative, staying in maybe ETFs that are indexed to some of the larger caps. Talk a little bit about that-why you're using the IWM. That's intriguing.

Jesse Anderson: Ultimately it comes down to that ability to generate income, and we do need some volatility in there. Right now, I'd say that we're able to get that in the IWM position.

I don't think we're ultimately tied to that for the long run. I think we see different indexes have different amounts of volatility, even over course of the last couple of years, when we look at it.

But for us, it's really just kind of gaining exposure to the broad market. And with that index, we quickly have access or exposure to nearly 2,000 companies. That's plenty of diversification, and we're happy with that level of exposure.

Kate Stalter: How about any sector ETFs? Is that an area that you're using?

Jesse Anderson: Outside of the broad market, we do use what we call satellite positions. They tend to represent asset classes or different regions.

These days, one of our satellite positions is the SPDR S&P Oil & Gas Exploration & Production ETF(XOP). And again, it comes in there, and not something you'd want to have a significant portion of your portfolio exposed to, but you definitely have a portion of it exposed to that.

And for us, we can allocate it, a piece of our portfolio, and then earn pretty good option premiums off of that because of the volatility that's involved. But again, ultimately, for the long run we're willing to kind of hold that position, and be in it for a long period of time.

Kate Stalter: How do you determine which sectors or regions or market caps that would be some of the satellite positions?

Jesse Anderson: The biggest thing is that volatility, and the amount that these ETFs are paying. And when we look at paying, we look at the covered call premium we're able to earn.

We also look at the one strike out of the money when we're looking to buy into a position. It's about where that premium is, because with our focus on income, our focus on generating that income cash flow month after month, volatility and the amount that that is paying is pretty critical for us.

So we'll, we have our list of ETFs-there's thousands of them out there these days, but we can kind of narrow it down and make sure that we've got ones with good, liquid option markets. That's something that has just evolved, that allowed us to introduce this portfolio.

But once we have our list of ETFs, ones with good efficient option markets, then it's just about looking at it and saying, "OK, where can we earn some premium?" And going in and allocating from that point.

Kate Stalter: To kind of sum this up: It's not about just going into an ETF. Really, the option market for a given ETF-that sounds like that's central to your decision to take a position.

Jesse Anderson: It's definitely essential. We have a bunch of different ETF providers out there, but for us it really comes down to which ETFs have options on them. Because you know that's a critical, crucial part to our strategy.

Then, which ones are liquid. You could consider the same ETF by one of the bigger three providers, and only one will have a good option market. So that's a pretty critical piece for us to go in and allocate to these positions.

• Also read: http://www.moneyshow.com/trading/article/40/OptionsIdea-27452/One-Is-Best:-Naked-Puts-or-Covered-Calls/

Energy master limited partnerships have become popular for their high dividend yields. But, says fund manager Quinn Kiley, investing in them as standalone vehicles can create complicated tax situations. He explains how his fund delivers yield, but avoids some of the burdensome tax issues.

Kate Stalter: Today our guest on the Daily Guru is Quinn Kiley, co-manager of the Famco MLP and Energy Income Fund (INFIX).

Quinn, as I understand it, your main focus is on pipelines and delivery, rather than exploration and production. So can you tell us a little bit about the fund's objective and your investing methodology?

Quinn Kiley: Sure. As you said, we're focused on energy infrastructure, primarily through what are called master limited partnerships, which is a niche of the energy world. They're publicly traded partnerships, and they're a great investment vehicle.

However, there are some tax complications associated with MLPs. This fund that we've launched a couple years ago is focused on more returns through the MLP asset class, but do it without the tax complications.

We're trying to get a relatively high-yield growth component in the returns, a low correlation to other asset classes-it's a great diversifier-and trying to do it with lower volatility. All through a publicly traded fund that provides a 1099 and solves some of the tax complexities of owning MLPs directly.

Kate Stalter: As you mentioned, this is a fairly new fund, formed back in 2010. What was the reason to form a new fund in the energy space at that time?

Quinn Kiley: Like I said, there are some complications with owning MLPs directly.

And although we have a large business focused on that strategy, we've noticed that there's a whole series of new exchange traded products and new funds that have come out, trying to address the tax complexity of MLPs. Because there's great investor demand to own them, but there are some hurdles to owning them. And in our view, a lot of these funds were flawed in structure.

So we wanted to develop a product that gave people the investor experience of owning the characteristics and attributes of MLPs, would replicate MLP performance over a cycle, but do it in an efficient manner. And this fund does it in a tax-efficient manner, unlike the other open-ended funds that are 100% MLPs.

And we're also trying to broaden the opportunity set here. We're investing across MLPs, similar energy infrastructure companies, and we're doing that across their capital structure. So not just equity; we're also looking to buy some of the bonds, which provide some of that lower volatility that I mentioned earlier.

Kate Stalter: Before we began recording today, we were chatting briefly, and you had mentioned that this particular fund really is something that could be appropriate for a wide range of retail investors?

Quinn Kiley: It's generally available on many of the broker-dealer systems that many retail investors have their accounts on, so it's easily accessible. It's a very affordable share price. You can buy as little as one share and there are no tax complexities associated with it, like there would be if you owned MLPs directly.

And those complexities, I keep generalizing them, but they're getting a K-1 instead of a 1099, having the obligation of potentially filing your tax returns in multiple states. And those complexities don't come along with this fund.

Additionally, a lot of investors do a majority their investing through retirement accounts, with tax-exempt accounts. This fund is appropriate for those types of accounts as well.

Kate Stalter: I wanted to talk a little bit about some of the holdings in this fund. Maybe just name two or three, and tell us why you like these?

Quinn Kiley: Sure. One name that we found interesting that we've owned for the majority of the life of the fund is Williams Companies (WMB).

And when we bought it early on in the fund, the theme was several fold: One, they're exposed across the energy value chain to the growth that's going on domestically in energy, as we're developing these shale reserves for both oil and gas around the country.

And Williams had exposure on the oil and gas side, the producing side, as well as, and primarily, on the infrastructure side-the pipelines that carry these products around the country.

And our view was that they were going to realize great growth and great value through those business lines. But also, they were the general partner in an underlying master limited partnership. We thought that the value there was not properly recognized by the market, and that there was an opportunity for a separation or reorganization of this business through separating the E&P business, and also a realization of the value of the general partner.

That came to fruition last year when Williams spun off its E&P business to its shareholders. And since then, we've had just great performance and a realization of value there. So that's one example of a theme that we've been exposed to throughout.

Actually, I should say it's two examples of themes that we're exposed to. We really like the idea of the restructuring theme, where there's huge growth and a need for capital in the energy space. You need to realize that capital in the most efficient form, and that can lead to restructuring.

And then secondly, the growth story that underlies all this is the development of shale domestically in this country. It's really a game changer for the energy spectrum across the board, and specifically to oil and gas companies.

Kate Stalter: I'm looking at a chart of this as you're speaking, Quinn. In addition to the dividend yield, you've got some nice price appreciation on this one in the past several months. Are you looking for these total return plays?

Quinn Kiley: I think that's fair. There are really two components to it. We think that yield is a significant portion of the return expectation inside the portfolio. We think it's an important expectation of the investors in the fund, so we want our own securities that generate that yield.

In the energy infrastructure world, you tend to have very stable cash flows. And that's because these are essential assets that are required for energy to be delivered around the country, which I like to think about as job one in the economy. If MLPs and energy infrastructure companies don't do that job, nothing else works. And that means that they have stable, visible cash flows.

The stable, visible cash flows can then be paid out of the stable dividend, and because they're associated with growth, and the growth of energy domestically, there's going to be a growth component as well. So that combination is a good total return story, but it's really anchored by the yield and the income produced by the assets.

Kate Stalter: Do you have maybe another name, or even two, that you can mention to us today?

Quinn Kiley: Sure, there a large MLP that is widely held, Enterprise Products Partners (EPD). It's a decent position in the fund, and it is exposed to natural gas and natural gas liquids, as well as crude oil and refined products all across the country.

It's the largest MLP by market cap and the most liquid by market cap, ad by daily liquidity, as well. And it's a great way for people to have exposure to MLPs in a single holding.

Now again, the tax complexities aside, it's a great single name to own. And it gives you exposure to all the good things that are happening domestically in the US right now, with significantly less commodity price exposure than you would if you were to buy an Exxon Mobil (XOM) or something like that.

And also it is entirely focused domestically, which we think is great, because there's a lot of geopolitical uncertainty. There are some issues going around in Europe, or whether it be the Middle East, that might lead to uncertainty in operations, as well as prices of commodities. So if you can curtail that risk exposure to the US, I think it's a good place to be.

Another name that we really like is Energy Transfer Equity (ETE). That name has been in the news recently because of two large M&A deals that they've done in the past year.

One, they have announced and then closed, which was the acquisition of Southern Union Gas, which was an MLP buying a corporation. We hadn't really seen deals like that in the past. And then just recently, they announced that they were going to acquire Sunoco (SUN), the large refiner and oil and refined-product pipeline company.

So you're starting to see these MLPs, which historically were a small niche area of the energy world, step up and grow. And because of that growth and because of the quality of their long-term growth plan, they are able to access the capital needed to do larger acquisitions.

So Energy Transfer is a great example of a mid-cap growing to a large cap, and Enterprise Products Partners, a great example of a large-cap MLP that is executing across the country.

Kate Stalter: Last question for you today, based on something you just said: Do you anticipate that the MLP area will be ripe for further M&A activity in the next few years?

Quinn Kiley: I do. I wouldn't go so far as to call for MLPs to continue to acquire large energy companies. It might happen on a one-off basis.

What I think you're going to see is that MLPs are going to continue to build and buy energy infrastructure across the country, and that's going to be a significant growth platform.

Historically, it's always been focused on buying assets-less so than companies. Today, you're starting to see them step out and buy more companies, so I think the larger MLPs have access to capital that will allow them to do big acquisitions.

But all MLPs have access to enough capital to do smaller acquisitions, and this has been to build out on top of their geographic footprint, so that's really the growth. Whether it's new asset by acquisition or new asset by building, that's the growth story of the MLPs.

Related Reading:

http://www.moneyshow.com/investing/article/44/DailyGuru-27817/Get-into-MLPs-Through-an-ETF/

http://www.moneyshow.com/investing/article/43/VideoTrans-27799/Good-Payoff-for-Disciplined-MLP-Investors/

http://www.moneyshow.com/investing/article/1/regBook-27661/Why-I-Like-MLPs/