The Culross Global Fund was shortlisted in the ‘Global Multi-Strategy $100m – $500m’ category at the Investhedge Awards 2007.

Global Multi-Strategy $100m – $500m Nominees

• Culross Global Fund
• Freestone Capital Partners
• Jubilee Absolute Return Fund
• Ouest Trading Managers
• Theta Deep Value Fund

Industry data indicates that $200bn of new money flowed into the Hedge Fund sector in 2007. Yet in December, markets behaved as though they were dominated by fund managers preparing for year end redemptions. Profits were being taken in a number of areas so many of the things that had worked in preceding months began to behave oddly at the approach of year end. Trends were difficult to discern. Our technology digitisation manager lost money as the tech sector came in for a major reassessment. Small cap opportunities have been few and far between in the past couple of months, but one of the two remaining managers in the theme had a very strong month. Asian consumer power was a similarly mixed bag; two out of three managers were profitable. The dislocation insurance theme did pay out during the month. Volatility plainly helps in this sphere and for one of the managers, December was his best month of the year. Our event specialist in Japan reported a strong flow of corporate activity enabling him to deliver a strong positive contribution. The BIC Managers all made money. So did each of the managers in the widening sub prime and credit spread theme.

Major valuation relationships appear to be shifting. In equities, consider the behaviour of growth vs value stocks, large cap stocks vs mid and small cap and big users of leverage vs the cash rich. It is odd to see a positive slope to the US yield curve when GDP growth is slowing. Currency volatility has started to reflect widely differing economic prospects. Real Estate valuations are diverging radically. Oversimplifying, commercial real estate markets in the US and Europe are weak, while in Asia, they are strong. Then there is the Credit market, which, below high grade, is basically shut. The credit issue has been the dominant factor in asset market valuation for the past 6 months and seems likely to remain in this position. Lower US rates will not change the availability of credit. This has been shrinking since the middle of 2007 as a result of a combination of diminished investor appetite and shrinking bank capital. The banks are losing money, but don’t know how much they have lost. Until the US housing market stops falling they won’t be able to find out. The impact of the Housing Market fall is clearly showing through in the consumer credit market. It will inevitably take some time before the extent of the US slowdown is clear, let alone its impact elsewhere. In the meantime, we expect markets to spend more time worrying about bad news than celebrating good and are positioned accordingly. We intend to circulate a more extensive analysis of our reviews on the prospects for 2008 shortly.

It may seem odd now, but in the first half of 2007, some commentators were arguing that low volatility had become a lasting feature of financial markets. Mind you, for some time, Politicians have been loudly proclaiming the end of the business cycle, so maybe some market participants were ‘believers’. December saw plenty of volatility. Market expectations on US rates swung back and forward. This was partly thanks to Mr Bernanke, and partly because of misunderstanding over the nature of the credit problem we are living through. At the beginning of December, markets wanted to believe that the worst of the bad news on credit was out. But then a number of major Banks set out to raise new capital in impressive chunks, producing public statements on the merits of being overcapitalised. It didn’t take long for the market consensus to interpret this as a sign of worse news to come and adjust accordingly. This adjustment process has a great deal further to run. Credit markets do not synthesise news into an immediate public market price change. It will take a long time for the problems to work through and for the extent of the US slowdown and its implications for the other major economies to emerge. We intend to circulate a more detailed analysis of our views on the prospects for 2008 in the next few days.

Two themes detracted from performance in the month. The managers in technology digitisation change were faced with a very sharp reversal in the market view of the prospects in their space. Interestingly, they are seeing increasing numbers of single stock short opportunities. Both the debt market opportunities managers also made small losses. The remaining eight themes were all profitable. Despite the gyrations of the Nikkei, the Japan managers made money, with the recently added event specialist leading the field. He continues to report a good flow corporate activity involving domestic players. The US recession theme made a very solid contribution to the performance for the month. All six managers in the theme made money. Three of the four asia consumer power managers produced positive returns too. In our dislocation insurance theme, there are two regional macro managers who are focussed on Asia. They are there in the expectation that the conditions the Asian stock pickers find difficult will suit these regional macro funds better. In December, there were opportunities for both; indeed one of the macro funds had its best month of the year. All the managers in the credit theme made money too, despite a savage profit taking decline in credit spreads just before year end.

Followers of financial markets have got used to the notion that December will bring a rally. Not this year! Another round of concerns about the credit crisis especially in the US accompanied a series of announcements about US Banks seeking help from foreign investors to rebuild their capital resources. Why do they think they need so much additional capital? Markets have assumed, rightly in our view, that there is more trouble in store. We will circulate a more detailed analysis of our view of the prospects for 2008 shortly.

The portfolio withstood the turmoil well. Two thirds of the mangers reported a positive performance in the month. In November, one of our fixed income arb managers found that an established price relationship between linked securities was pushed to an extreme. His judgement was that the loss caused by this in November would unwind. In December the valuation linkage between the bonds reasserted itself and he made a handsome return in the process. The mortgage arb specialists made money as well. In merger arb, Deals worth $340bn were announced in the US, a run rate that is not much reduced from the monthly average in a year that saw deals announced worth $4.75 trillion. But the High Yield market is closed and Bank debt is much harder to come by. So merger spreads were marked down to reflect increased risk that deals may fail for lack of finance. Two of the three Merger specialists in the portfolio lost money. Convertible arbitrage produced mixed results and the equity pairs arb Manager produced a small profit.

A new theme was added to the portfolio for December, Instrument Arbitrage. A non US Company that seeks to make itself attractive to dollar based investors can arrange for its shares to be repackaged into a Depositary Receipt, either American (ADR) or Global (GDR). This enables investors to buy the shares in dollars and settle in New York or London rather than having to transact the investment in the country and currency of the Company’s origin. Suppose the Company in question is listed in Hong Kong. Its shares will then trade in HK in HK$ and in the US in US$. Depending on the strength of the demand in each centre, to keep the two prices in synch, arbitrageurs move shares between the two formats, HK Listed and ADR/GDR’s. It doesn’t matter whether there is more demand for locally listed stock or the version traded globally. What matters is that demand pressure varies enough to put the price relationship under stress. The manager we have added has spent the past 10 years working as a specialist in this type of Instrument Arbitrage. Until a year ago, he practised his craft at the Proprietary trading desk of one of the worlds largest Banks based in Hong Kong. Having tracked his progress as an independent operator, we have decided to add his fund to the portfolio from this month.

Culross Global Management Ltd was shortlisted ‘European specialist investment firm of the year’ at the Funds Europe Awards 2007.

Growing risk aversion characterised market behaviour in November. Global equity markets fell over 4%, the S&P by 4.5%. Bank stocks and bank reputations both weakened further. This was a month in which the level of market stress was high and its impact was widespread. Of the eleven managers in the portfolio, four made money, three broke even on the month and five recorded losses. In merger arb, hedges against worsening credit paid off, but the same conditions that drove credit markets to weaken, caused five or six substantial takeovers to be abandoned. These were predominantly deals initiated by financial buyers. Sainsbury’s, the UK supermarket, was the subject of a bid approach in the summer. In November, the buyer, the Sovereign Wealth Fund of Qatar, withdrew its bid and the stock fell 20%. One of our managers was impacted by this.

In fixed income arb there was plenty of volatility in evidence. Volatility pushes valuation relationships between connected securities out of line, generating opportunities. But these unusual price moves can sometimes range wider and persist for longer than the manager expects. Provided the connection between the securities is real, that doesn’t mean that he will lose money. But it can easily mean that month to month results can be uneven until established valuation relationships reassert themselves. One of our fixed income specialists found himself on the wrong end of this phenomenon in November.

Mortgage arb was modestly profitable in the month. Convertible Arb made the greatest positive contribution to the month’s performance. The Convertible market in the US is not yet fully reflecting the increase in the volatility evident in equities. Since convertible bond managers are long of volatility most of the time, this is a promising indicator for the future.

November was a testing month for both long-short equity managers and traditional long only managers. By mid-month all major equity market indices were posting substantial falls and even after a rally typically ended the month down 5-7%. Five of the eight portfolio themes were weighed down by these problems and produced negative returns. The three profitable themes comprised, predictably, the two counterbalancing themes – Widening sub-prime and credit spreads and Dislocation insurance – plus the Japan structural change theme. For the second time this year when markets experienced a stress month the Dislocation insurance theme paid out handsomely and protected the portfolio downside. What was really encouraging though was the added contribution made by the Japan theme. We think we have found a star manager who is exploiting the myriad of opportunities in Japan’s equity market. We see the alpha source and process as being highly uncorrelated and our conviction is reinforced by knowing that so much foreign capital has deserted Japan. At the end of the month this manager weighting was more than doubled to 6% and will rise further through year end. In light of our positive experience to date, we also increased the weighting of the best performing Dislocation insurance manager to ensure the portfolio carries sufficient protection. Otherwise there were no major theme weighting changes.

We expect higher volatility to persist well into next year as investor views about a) central bank policy, b)the outlook for credit markets, c) the risks of inflation and d) the prospects of Asian decoupling continue to diverge and oscillate between extremes. Readers will know our thinking on these issues and where we have high conviction we have positioned the portfolio with themes and managers we hope will take full advantage of the favourable opportunity sets being presented.

November was the second consecutive month in which rising risk aversion characterised the behaviour of financial markets. Global equity markets fell over 4%, the S&P by 4.5%. The level of market stress was high and its impact was widespread. At the theme level, the portfolio contains two built in hedges both of which were profitable. The dislocation insurance paid out handsomely. Weakness in credit markets led the wider market decline and so provided a wealth of opportunities to the managers comprising the widening credit spread theme. By contrast, the managers in the asian consumer power theme found the going difficult; all four losing money. Both managers in the technology theme were also loss making. In each of the remaining portfolio themes, results were mixed. Three Japanese specialists made money. Either they were expecting trouble, or, in the case of the newest addition to the portfolio, were nimble enough to run net short in the first half of the month. One of the financial services specialists lost money but the other was profitable. Two of five European specialists made money and three out of six in the US theme were profitable too. Taken overall, half of the managers in the portfolio made money, and in amounts that outweighed the losses incurred by the other half. During the past 18 months, the priority for the portfolio has been to build its defensive strengths. Identifying themes that can make money when markets are stressed was the first part of this task. Investing with managers with the ability to run short books that can make a meaningful contribution to their results has been the second major goal. In both cases, these are continuing priorities, but it is gratifying that the fund has been profitable in both August and November, neither of which were easy months in which to generate a positive return. Looking forward, we do not see any signs that the environment is likely to get easier.

The Culross H Fund has been awarded ‘Best performing diversified fund of hedge funds over 1 year on a risk/return basis’ at the 2007 Hedge Fund Review Awards held on the 14th November 2007.

About the awards

The Hedge Funds Review™ awards are the most sought after accolades in the industry. The hedge fund investment process relies on more than just numbers and our judging process recognises this. The European Fund of Hedge Fund Awards remain the only signature event held exclusively for the European fund of hedge fund sector and as such continue to attract the top names from the industry.

Chaired by the Editor and Alternatives Journalist of the Year 2007, David Walker, the judging panel is impartial and unbiased and seek to reward genuine performance and success. Previous recipients of these awards have seen as much as a 10 fold increase in their AUM in the 12 months after winning – making the shortlist alone guarantees managers increased awareness in the investor community and an enhanced reputation.

Methodology

The judging process begins by running a screen across all entrants, selecting managers with a significant European presence, typically some investment or due diligence function.

For 1 year awards the period under consideration is July 1st 2006 – June 30th 2007

Each fund of hedge funds is ranked against its peers by its annualised return, its Sharpe ratio and its annualised return over its worst month, for the relevant period. These three rankings are added to produce an aggregate ranking and a long-list. Other metrics such as volatility, total return, percentage of positive and negative months and age and size of fund are also generated.

The judges then discuss the various merits of the funds, from both a qualitative and quantitative perspective. Whether groups are of a sound basis and expert management that could be expected to continue producing, are also taken into account and a shortlist is drawn up, typically of around six names. From this a winner is chosen

In the past few weeks, credit has reasserted itself as the dominant influence on market sentiment and on US economic prospects. Write offs by the major Banks on their portfolios of sub prime debt have increased sharply. At $40bn, they are already big enough to cause trouble. Falling collateral values and a declining market for housing make it difficult to assess the scale of the damage that these securities could still cause, but $200bn represents the middle ground in the range of considered estimates. The Banks are not likely to bear 100% of any ultimate loss, but viewed in the context of total Tier 1 capital resources of $2000bn for US and EU Banks, the issue has the potential to cause more problems. And this only deals with the impact of sub prime securities losses. It remains to be seen how the CMBS and other structured credit markets cope with falling collateral values and the coming US slowdown. We expect the losses on the books of the Banks and the opportunities for Hedge Funds that understand credit, the financial services industry and real estate markets to multiply hand in hand.

Our widening sub-prime and credit spreads theme made the largest contribution to the October result. Dislocation insurance did not pay out in October, with one manager profitable and one recording a small loss. On the flip side of this, the managers pursuing the Asia consumer power theme had an excellent month. So did the India and South America specialists, with one of the India managers producing the Funds highest nominal return for the month. We have decided to reduce the exposure of the portfolio to small cap stocks. In an environment where liquidity is constrained and US growth likely to decline, we expect market conditions to be unhelpful to managers in this space, however skilled they may be. The new European manager made a sober start.