In December, two thirds of the managers in the portfolio made gains. At the theme level, three material positive contributions accounted for the bulk of the return. One of our nine themes detracted, and then by less than 20bps.

All along the credit curve, spread compression was a big story in 2009.In High Yield, spreads fell by two thirds. This year will not see a rerun, but a different set of appealing opportunities is showing through. The distressed cycle is at or near its peak, weighty refinancing schedules loom over the market and deleveraging is a continuing priority for man. Credit Spreads in Transition is weighted at 19% in January. The manager line-up now covers Asia in depth, as well as the US and Europe. It covers corporate securities, financial sector paper and some US Residential Mortgage backed bonds. With the addition of the newly created Culross Long Term Alpha Fund, it incorporates some exposure to stressed and distressed securities, especially in the US. One by-product of the boom in structured credit is that the tool kit available to specialist credit managers is much wider than it was. Spread relationships between cash bonds, indices and CDS are a simple example of the opportunities that can be accessed in corporate credit today. Managers now have flexibility over the precise net exposures they choose to run. Prior to the crisis, the skills and systems required to make a success of investing in the anomalies that arise in this environment were not found outside the Investment Banks. Not only is this is no longer the case, but the banks do not have the capital to act as they might wish.

December’s profitable theme return in Relative Sovereign Opportunities was a composite of three positive and two negative manager results. Although the Fund made money in this theme in 2009, it has been frustrating to see this pattern recur during the year and cost us a proportion of the opportunities available. However, the story is not over. Greece has drawn attention to the changes taking place in the old order of creditworthiness. Record prospective public sector deficits are a big problem and, at the very least, will reduce the potential for western economies to grow. In those geographies in which growth does show through, markets face the withdrawal of the fiscal and monetary stimulus that produced the good news. Will this be well handled and skilfully timed; will it be co-ordinated? Meanwhile, Asia has resumed its growth path, unconstrained by significant personal or public sector debt. Our view is that there will be sharp regional and national differences in the post crunch consequences of loose policy. These differences will drive the behaviour of exchange rates, interest rates and sovereign credit spreads as well as equity markets. Our theme is designed to focus on this and carries a weighting of 8% from January 1st.

The third contributor to the December result was Japan Corporate Event Opportunities. We will be down to three managers here by the end of January. Their emphasis is on short term anomalies rather than the macro outlook.

For December, all but one of the managers in the portfolio turned in positive results, generating profits in all themes and the fourteenth consecutive monthly gain for the Fund. In the year 2009 as a whole, all themes were profitable. Convertible Arbitrage and Mortgage Arbitrage contributed just over two thirds of the return. However, this should not obscure the fact that, together, the remaining four themes, contributed in excess of the Funds stated target return of LIBOR +300bp.

In the month, four themes contributed the bulk of the gains.

Merger Arbitrage made money in the month. Spreads have tightened during the year. This partly reflects the fact that, we did not see the wave of transactions predicted by the intermediaries. Lawyers and Investment Bankers see preparatory work well ahead of public merger announcements. Highly unscientific feedback from this community suggests considerable ongoing activity, which bodes well for 2010. So does the strength of corporate balance sheets overall. The Companies that make up the S&P index have doubled their net cash reserves to $1.5 t in the past 4 years. Of course they can make acquisitions with their own stock, but historically, large cash reserves tend to embolden potential acquirers.

Measures of volatility continued to decline in December with the Vix for example, now below its 10 year average. Convertible Arbitrage was profitable despite this headwind. New issuance in the US finished the year at $40bn, the lowest total in the past 10 years. In Asia, Japanese Companies were the largest issuers of CB’s. The level of new equity issuance in Asia in 2009 (60 IPO’s in HK) lays the foundation for an increase in the population of potential issuers in the year ahead. 2010 will not be a rerun of the exceptional return achieved last year. But the fact that the sector has not been flooded with paper, and valuations that have stabilised at levels that are still cheap to theoretical values, offers investors the prospect of a constructive start to 2010.

All four managers in Fixed Income Arbitrage were profitable in a month that saw US Treasury yields increase from 0.67% to 1.14% in the two year note and 3.21% to 3.85% in the 10 year. Towards the end of the year, liquidity diminished faster than the new supply of bonds, so the US Treasury had to provide increasing incentives to the Arb community to induce the level of support they needed the market to provide.

Our Mortgage Arbitrage managers captured the spread on their portfolios and made money from their interest rate hedges as well.

The Instrument Arbitrage manager finished off a strong year with a positive month. He saw opportunities in ADR arbitrage as the Tokyo market turned positive in tone and made money in dual listed stocks. The persistence of interesting spreads in these activities is a barometer of capital allocated to the field of arbitrage. When the Investment Banks have money to use for this type of proprietary trading, these spreads come under pressure. Happily, they are still at equivalent levels to those seen a year ago.

Four of our seven themes were profitable in December. Two were neutral in their impact and one was negative. The first three of these themes generated the bulk of the 2009 return. The remaining three themes had a negligible net impact during 2009.

After a sickening decline in 2008, Credit markets staged a spectacular recovery in 2009. The Merrill Lynch US High Yield index had a spread of 1812 bps in January and ended December at 639 bps, a move of 65% while the Barclays Investment Grade Index tightened 69%. Spreads moved down 126 bps in High Yield in December and 34 bps in Investment Grade. Our Credit Spreads in Transition theme topped the results for the month and for the year, producing half of the Funds 2009 return from a 30% average weighting. The prospects for Credit remain strong in 2010. We have developed a new vehicle, the Long Term Alpha Fund, which will focus initially on this sphere and have swapped holdings accounting for 4.6% of the H portfolio into it. This will give H a broader exposure to managers who can capture opportunities arising from stressed and distressed credit as the default cycle peaks.

All four managers in the Asian Consumer Power theme made money in December. In the year, the theme contributed a third of the overall return. All our managers latched on to improving fundamentals as 2009 unfolded. All are well placed to capitalise on the prospect of the region continuing to grow at a faster pace than the rest of the world, even if this growth path demonstrates some volatility.

Relative Sovereign Opportunities contributed a fifth of the annual return of the fund. In December, it made money despite divergent manager returns. The best of them read the background trends and their short term impact with great dexterity. Shorts in Sovereign European credit, as did longs in Asian currencies and a short in the US$, which he lifted prior to the yearend $ rally. In common with his peers, his 2010 agenda is to track differences in the timing and impact of the withdrawal of stimulus and in the emergence of growth. Mature Industrial economies are following a different trajectory from EM, but there are big differences within regions as well. The theme looks to us like a very exciting prospect.

Japan Corporate Event Opportunities was the fourth contributor to December’s positive return. The theme has been radically simplified. It now contains a manager whose approach is to position his fund so as to take advantage of short term anomalies in Japanese equities. This worked well in the month. We also have a residual exposure to a warrant Fund, a useful barometer of equity sentiment.

The Financial Sector Dislocation theme lost money in the month. Since the spring, the sector has seen an impressive bounce in valuation terms. Yet, in the US especially, the fundamental credit picture remain dire for a large number of midsized Banks. If broad economic recovery takes longer than markets anticipate, a cautious view on the financial sector offers some defence.

Of the nine themes in the portfolio in November, three contributed positively to returns, three lost money and three had no significant impact.

Credit Spreads in Transition was profitable; all managers generated positive returns including the newly added Asia specialist. The Dubai news jolted credit markets and contributed to a net widening of High Yield spreads over the month, the first such move since early in the year. Our managers are ready for a market in which weak balance sheets and refinancing risks outweigh beta moves.

Asian Consumer Power was a positive performer. We have added a talented fourth manager.

Financial Sector Dislocation made a small profit, taking advantage of the two way pull currently present in the sector. Policymakers have designed things so that Banks can earn fat spreads and rebuild their capital with those profits at no further taxpayer cost. But the population of stressed borrowers is growing, and while some Banks will earn enough to accumulate new capital faster than additional bad loans are written off, others will fail, or at least fail to emerge from public sector domination as quickly as markets expect them to.

At 23%, Relative Sovereign Opportunities is the largest allocation in the portfolio. Its November performance was neutral. The news that Greek sovereign debt faces a ratings downgrade emerged during the month and despite the potential significance of this for Greek Banks which might find themselves unable to use their own Government bonds as collateral for the ECB borrowings on which they rely, other European Government Bond markets hesitated only briefly. Nine months ago, this would have engendered a systemic scare. Now, local fundamentals matter most, and, as the fundamentals assert themselves, opportunities multiply.

In Japan Corporate Event Opportunities all managers lost money. This disappointing outcome reflects a difficult month in which stock indices fell over 6% in the face of truly remarkable yen strength. We had already taken action to completely revise the construction of this theme, reducing exposure in absolute and market risk terms, but this transition was still in process.

In the last monthly report of 2009, the pattern of returns for 2009 so far is as follows. The largest percentage return and the greatest portfolio contribution has come from the average 9% allocation to the credit theme. Inflation/Deflation Uncertainty has a similar weighting and has generated a solid contribution, as has Relative Sovereign Opportunities with an average 21% weighting. The Energy theme was introduced in April and has generated a double digit percentage return on its 8% allocation, producing a contribution to portfolio returns of just less that 1%. Japan has been a drag on performance with a negative 0.7% overall contribution. The remaining five themes in the portfolio today, together with two themes terminated in Q1 have not had a material impact on the year’s results so far. In terms of its net market exposure, the positioning of the fund has been cautious throughout the year and is still only modestly positive.

The November return was generated by four themes. The Mortgage Arb specialists absorbed the news that the Fed had reduced its commitment to the purchase of Government Agency issued mortgage backed debt by $25bn. In the original Quantitative Easing programme, purchases of $200bn of debt were scheduled as part of a wider initiative involving buying $1.25 trillion of Agency bonds as well but the impact of the programme is such that the last debt tranche is now considered unnecessary. So if purchases are now tapering off, is the unwinding of QE in sight? It appears not. Mortgage cost and availability has yet to normalise and remains a key issue in the Administration’s attempts to heal the housing market in the US. Newly created mortgage bonds are not flowing into the market in size and the Fed will not be a seller of mortgage paper at this stage. In this environment, our managers can build their portfolios around a core bloc of positive carry positions adding cheap optionality to enhance the returns.

The Fixed Income Arb theme was extended by the addition of a new Asian based fund which made a strong initial contribution to a positive theme performance. Their capital structure and intercompany books made the bulk of these returns. The fund only looks at fixed income securities, but ranges across the Asian region excluding Japan. Two of the remaining three managers were also solidly profitable in November.

Convertible Arb also made a strong contribution. In the US, issuance so far this year has run at an annual rate of approximately half of the 2008 level. In the spring of this year, when capital markets were just beginning to thaw, convertible issues were among the first sources of corporate funding available, and there are a number of instances where the issuers that were happy to raise money on the terms available then are having second thoughts now. So some of the issuance of that vintage is being bought back to be replaced by cheaper current sources of finance, and one of our managers generated a good portion of his return in the month from these buybacks. More generally, limited issuance combined with the retirement of existing paper creates a very positive market environment.

Instrument Arbitrage was the fourth contributor in November. ADR relationships to local markets were relatively consistent during the month, making the arb between them solidly profitable.

Multi Strat Diversified Arb represents a new theme, added to the portfolio on November 1st and initially comprising one manager. This firm concentrates on the Australian market and sets out to build a widely diversified portfolio of differing risk positions built around a core long volatility position. The satellite strategies include event opportunities, yield anomalies and convergence strategies. The market neutrality of the resulting portfolio is a primary objective of the analysis that goes into its construction.

Of the seven themes in the portfolio in November, four contributed positively to returns and one lost money.

Credit Spreads in Transition earned half of the months overall result. All four managers made money and the theme had the largest weighting in the portfolio at just less than 30%. Asian Consumer Power also made a substantial contribution, despite having to absorb one negative manager performance.

The Financial Sector Dislocation theme was also positive, taking advantage of the two way pull currently present in the sector. Policymakers have designed things so that Banks can earn fat spreads and rebuild their capital with those profits at no further taxpayer cost. But the population of stressed borrowers is growing, and while some Banks will earn enough to accumulate new capital faster than additional bad loans are written off, others will fail, or at least fail to emerge from public sector domination as quickly as markets expect them to.

Finally, Relative Sovereign Opportunities made a modest contribution for its 20% weighting. Finance ministers conferences used to be about big common problems, but increasingly, domestic differences dominate the similarities of Global issues. Fresh from taking the entire Irish Banking system into public ownership, Brian Lenihan, the Irish Minister for Finance, has just introduced a budget cutting social benefits, reducing public sector salaries between 7 – 15% and charging a 7% levy on Pension Funds. Irish GDP is still forecast to fall in 2010, though the social and political consequences may take longer to show through.

The yen strengthened to 84 to the $ in November. Shares of exporters suffered, the Topix fell 6.1% and the Nikkei was 6.9% lower. In Japan Corporate Event Opportunities, all our managers lost money in the month.

In this last newsletter for 2009, a review of the theme results for the year so far shows that Credit Spreads in Transition with its average 20% portfolio weight has generated half the fund’s overall return. Despite its more modest average 8% allocation, the Asian theme accounts for a further quarter of the performance as the fundamental strengths of the Asian region have reasserted themselves. There was no dramatic domestic asset overvaluation there in recent years and Asian financial companies had minimal exposures to the ‘toxic’ assets that caused trouble in the west. Consumers have savings, useful for absorbing shocks and more importantly, so do Governments, which have responded to slowing GDP with fiscal stimuli that do not hobble future growth. Relative Sovereign Opportunities has generated a fifth of the portfolio return, off an average 25% portfolio weighting.

The detractors have been Japan with an average 9% weight and the financial sector theme, weighted at 21%. In both these cases, the negative return has been approximately 50 basis points at the portfolio level. Their potential as diversifiers of risk has been proved in both of the previous two years. In 2009, they have performed this role at limited cost.

The Culross Global Fund has been awarded ‘Best performing diversified fund of hedge funds over 3 years’ at the Hedge Fund Review’s 8th Annual European Fund of Hedge Funds Awards held on 26th November 2009. This is the second year running that the Fund has won the 3 year award.

The Global Fund also achieved a Highly Commended nomination in the ‘best performing diversified FoHF over 1 year’ category. You can view the Fund’s profile at the HFR site.

Culross Global Management Limited has been recognised in the ‘Best Overall Group’ category receiving a ‘highly commended’ at the Hedge Fund Review’s 8th Annual European Fund of Hedge Funds Awards held on 26th November 2009.

Since the dark days of the first quarter, financial markets have been propelled on a rapid recovery path by massive fiscal and monetary stimulus. The risk of the failure of the financial system has been brought under control and, in most cases, GDP declines have been arrested. Critically, US GDP grew at an annualised 3.5% in Q3.

In the face of two Australian and one Norwegian rate rises, October was the month in which financial markets began to look beyond stimulus and ask – what next? Will this recovery be like those we have seen before? In our view, it will not. The IMF estimates that outstanding Government borrowings in the G20 will be 118% of GDP by 2014. There is wide dispersion in the fiscal standing of G20 countries, but these are record peacetime numbers and represent a major challenge. To get back to 80% will require a combination of tax increases and spending cuts in the order of 6.7% of GDP over 10 years; 8% for a return to pre crisis debt levels at 60% of GDP. Who is going to vote for that? If they are sustained, large budget deficits put upward pressure on rates, reduce private investment and depress living standards.

Then there is the monetary stimulus. Although widely deployed it is most obvious in the US and UK where, through their use of QE, Governments own bonds worth 12-15% of GDP. This manoeuvre was designed to fend off deflation by relaxing monetary policy. Once victory is declared in that battle, these holdings will need to be sold in addition to the new bonds required to fund the deficit and refinance maturities. There is no precedent for the smooth timely withdrawal of monetary stimulus on this scale. Yet markets are pricing perfect policy execution.

The themes that make up our portfolios reflect the view that a rapid return to coordinated global growth, in an environment of low inflation and steady asset markets, is not the most likely outcome. In fact we think it is inconceivable. It is too simplistic to describe the present position as ‘a boom in Asia and a liquidity driven bubble in the West’ but regional differences in economic prospects are obvious from a comparison of government finances, and regional growth differentials can be expected to widen. Within regions, national policy and differences in its implementation will be revealed under the scrutiny of the vigilantes of the foreign exchange and bond markets. The same volatility in the macro variables will also make an impact at the sector and corporate level.

Theme results for the month were quite tightly grouped, four were positive, four negative and one was neutral. All the managers in the Credit Spreads in Transition theme made money. But there were managers on both sides of the profitability divide in all the other themes. Turning points are only ever identifiable in hindsight, but within these manager results are indicators of some very odd valuation swings reminiscent of past sea changes in market behaviour.

Three themes made money in October. Our Mortgage Arb managers continued to harvest the historically attractive spreads available in the asset class. In addition, they have begun to consider the scope offered by mortgage securities to acquire cheap or even no cost option exposure to the possibility of rising short term rates in the US during 2010.

As the market impact of Quantitative Easing in US Government bonds fades, the environment for Fixed Income Arb has been dominated by large Government bond issuance. However, our managers report signs of rising levels of activity in trades that hedge future inflation. The inflation linked sector is the first place to look for this cover, but there is significant interest in long dated options that profit from higher nominal rates some years ahead. The Arb operators don’t particularly care what inflation is, but they like the opportunities that this kind of non specialist interest gives rise to.

In Convertible Arb, we added a new manager to the theme at the start of the month, an expert in the field of hybrid securities with a particular emphasis on Preferreds. Preferred stocks have been in the spotlight lately as a result of two connected factors, their past popularity among Bank issuers and the horrifying experience ‘enjoyed’ by many of the original owners of this Bank paper in the past year. Many of these either had no idea of the risks they were taking on or paid them no attention. The skill set of this manager consists of an ability to compare the valuation of the hybrid security with the valuation of the component credit, equity and interest rate elements and to understand the market context and its influence as well.

Merger and Event Arbitrage recorded a modest loss. Spreads on announced mergers have been through a phase of compression this year, but widened slightly in October. At the end of the first quarter, the gap between the valuation of the shares of a typical takeover target and the value of the offer was at record wide levels, in many cases in the 20-40% range. Today we are back to a more normal 5-15% span of opportunities. Yet there are still anomalies. For example, there is a tendency for the largest transactions to offer the widest spreads, partly because there is still much less capital available to absorb these opportunities today than was the case in the past. Transaction volumes have increased recently and we expect this trend to continue. Strategic buyers have been ramping up their activity, but October also saw the return of the financial buyer as TPG agreed to pay $5.2bn for IMS Health and, in a private transaction, the Anheuser Busch theme park business was sold to Blackstone for $2.7bn. For the first time since the financial crisis began leverage was available to enable these transactions to proceed.

Instrument Arb had a negligible impact on the month’s results.