Q:  How would you describe your investment philosophy?

A: We are very conservative and our philosophy is, first and foremost, capital preservation, and then, good returns consistently achieved year in and year out. We focus on risk-adjusted returns, not relative returns. We try to be non-correlated to both equity markets and interest rates. Our goal is absolute positive returns regardless of what the market’s doing; it's not designed to outperform the S&P 500.

We employ various hedge fund managers that have successfully executed their strategies in the hedge fund arena. We pioneered putting together multiple hedged strategies in an openend no-load mutual fund, so that it could be more acceptable and accessible to the broader marketplace.

A focus on risk adjusted returns is rare in the mutual fund arena; it has almost exclusively been the domain of hedge funds until recently. But, you have to be an accredited investor to participate in a hedge fund, meaning that you may need half a million dollars just to get in. Now it is more broadly accessible, both directly and through financial intermediaries, such as advisors and brokers.

The Fund is targeting financial intermediaries primarily because it’s a complex product. It’s not as simple as most retail mutual funds, which tend to have very narrow objectives. Generally, the Morningstar style boxes of large-cap value or small-cap growth are much easier for the retail investor to comprehend.

Overall, in Alpha we look for high single-digit returns, let's say 8% to 10%, but with very diminished risk metrics. We target a market beta of about 0.10 versus the S&P being 1.00, so we're quite market neutral and have much lower volatility than the general equity markets.

Q:  Could you explain your concept of risk-adjusted return? Which risks are you adjusting?

A: It’s adjusting the return expectation relative to the risk taken. We tend to focus on beta and standard deviation. Beta has a component of correlation to the market as well as volatility. Basically, if you get a 10% return by being long the S&P index, you have a beta of 1.00. Conservative hedge fund of funds have returned 8% plus per year over the last 15 years. If you're getting 2% more by being long the market, the question is, at what additional risk?

I think that for many people who have accumulated a great degree of wealth already, the goal is to protect principal first. It's great if they can get a return well above the money market rate, but they really don’t want to take significant risks to do that. That’s where we think that absolute return strategies make a lot of sense for the mass affluent investor. That’s the void in the mutual fund marketplace that needed to be filled.

Many people intuitively know that they are more risk averse than they used to be, but they may be still thinking in terms of just stocks, bonds, and cash. Today, fixed-income is not the safe haven it used to be, so if investors can get high single-digit returns, but without the greater risk of negative return periods associated with equities, that might be exactly the area for investors to look into.

Q:  What's the strategy for achieving this goal?

A: Our strategy is to select hedge fund managers with various styles that individually are market neutral. We look for managers with a demonstrated track record of producing consistent risk-adjusted returns. We have a bias towards fundamental managers as opposed to quant models. Just like in the world of long equity funds, where most managers are a bit more fundamental in their approach; they do research and decide which of the different stocks should outperform their peer group.

But, we’re looking for managers with a dual “hedged” portfolio, or longshort strategies. That means that they select not only the stocks that should outperform their peer group, but also the ones that should underperform. By being equally long and short, it doesn't matter so much if the market’s going up or down, but whether the long stock positions outperform the short stock positions.

Q:  How do you research the hedge fund managers?

A: We do our research much as a typical hedge fund of funds would. There are fairly industry standard due diligence questionnaires that are looking at investment philosophy, depth of research within the shop, track record, compliance, and risk controls for these various disciplines. It’s not unusual to find managers with two different track records: one in the early years of operations and one when they later employ certain risk controls that allow them to retain 90% of the net return, and get rid of 50% of the volatility. You can always get back to the prior return level by using modest leverage, which we also employ in our Fund.

We also look at the different underlying strategies to make sure that the securities are fairly liquid and can be readily priced by independent means, because of the uniqueness of our product. Despite using hedged strategies, we are an open-end mutual fund that has to produce a daily net asset value for our shareholders. We don’t want to rely on the sub-manager to price their portion of our portfolio because that’s been one of the hedge fund world’s problems in the past.

Once we fund a manager, we have 100% transparency to what they're doing. We usually start with a smaller amount than we plan to invest, and at this point we can give a higher level of scrutiny than a typical hedge fund of funds manager has with their underlying funds.

Because the managers execute their style within our Fund, we see all the trades, all the positions, and how they are valued independently. That's an ongoing due diligence process, which makes sure that the managers are executing the strategies as advertised. We also make sure that they are up to speed on any nuances of dealing with a mutual fund. Then, once we are comfortable, we can fully fund their account.

Q:  Could you highlight your portfolio construction process?

A:We use a model that helps to optimize the portfolio by using all the statistics on each manager and by looking at historical patterns of correlation to the market. Currently, we have 11 strategies and by the end of the year, we’ll have about 15 to 20. Ideally, we would like to be in the 30 to 40 range, where a lot of conservative hedge fund of funds are, because that diversification provides an optimal non-correlation effect to dampen down the beta and the standard deviation, while keeping returns pretty stable. It winds up increasing the predictability of returns.