All six active themes made money in April, but Credit Spreads in Transition (35% of NAV), Asian Consumer Power (12.4% of NAV) and Energy Market Opportunities (8% of NAV) contributed the lion’s share.

Events in Europe have exerted a pronounced influence on financial markets everywhere since the end of April and created a degree of dislocation in the process. The May 9th Euro area liquidity fix was of sufficient size to startle market participants, but many of the details relating to its implementation have yet to be clarified. Neither are the deficit reduction plans announced in Spain and Portugal entirely clear in their scope. The final outcome of this story depends not only on the capacity of the Club Med countries to adjust their economies but also the willingness of their populations to accept the pain of these adjustments in order to repay lenders in full. By agreeing to intervene in debt markets, the ECB has surrendered its independence. Even if it sterilises the monetary impact of these purchases, the Central Bank will end up as a major creditor of weak sovereign borrowers. If, or more likely, when one of them is forced to restructure, the loss will be borne by the Euro bloc and the impact on private sector institutions reduced.

Relative Sovereign Opportunities produced a gain in April even though three of our four managers had small losses. The theme first appeared in the portfolio in April 2009. Events are playing out along the lines envisaged in our thematic analysis then, as sovereign credit and currency markets occupy centre stage. Yet, although the theme results are positive, they are frustratingly modest.

Both managers in Energy Market Opportunities made money. Oil rose to a 19 month peak in $ terms in early May but has since slipped back in line with the general weakness in commodity prices. The loss of life and the environmental impact of the accident in the Gulf of Mexico have been well documented, but its likely influence on future oil production is a bigger story. Recent discoveries have either been in politically challenging geographies or in deep water. Inhibitions on the development of these fields will further underpin future real energy prices.

Of our Asian Consumer Power managers, one nimbly took his profits in April on his Chinese bank and property stocks. A second sees enticing opportunities in consumer goods stocks as prices retreat. Current Chinese policy initiatives represent another chapter in the story of engineered growth by sector and by region. This time, less developed inland regions are favoured over coastal areas, and the construction of smaller cheaper homes is favoured over higher end projects. Equity market deflation is a side benefit. To adherents of the philosophy of the ‘invisible hand’, growth manipulation policies may appear unsatisfactory. But the key point is that for policy makers in China, a miss on the upside is much less dangerous than an unplanned slowdown.

Five out of seven themes made money in March.

The spread on the Merrill Lynch US HY index tightened from 660bps over to 585bps over, while High Yield bond funds received inflows of $1.8bn in March. Investment grade bond spreads are back to the levels last seen in November 2007. In the first quarter, indices of defaulted US bonds and loans are up 25% and 8% respectively. Credit Spreads in Transition was the top performing theme in the portfolio.

Net investment flows into the Asian region in the first quarter are estimated to have totalled $10bn, compared with a bit over $50bn for the whole of 2009. Yet the contribution that the Asian Consumer Power theme made in March was driven by favourable news at the operating level in many companies held by the funds involved. It is encouraging that the managers report a continuing flow of new stock ideas at attractive valuations.

Our Energy Market Opportunities theme was the third largest contributor to March returns. Crude oil broke out of the $70-80 range in which it had been stuck. This move was accompanied by a fall in volatility and, less surprisingly, by a decline in inventories both in the crude market and in certain refined products. It was also significant that oil rose against a background of dollar strength. The optionality built into the fund of our oil trading manager benefitted from these developments. The equity specialists in the theme had a mixed month.

Japan Corporate Event Opportunities had its best result in some months.

During March, Australian rates rose another 25bps, making a rise of 100bps since October. Malaysia became the first emerging Asian jurisdiction in which rates rose; India followed soon after. The posture of Central Banks in Canada, Sweden and Switzerland also changed. We do not expect the major manufacturing and service economies to raise rates now or in the near future, but natural resource based countries are experiencing different pressures and must adjust policy accordingly. Traditional relationships between commodity demand, inventories and prices are weaker today than they have been historically. This may reflect new demand patterns, the increasing influence of the financial investor or something completely different. But it represents another potential source of volatility in the macro picture. Relative Sovereign Opportunities made money in the month and we added a fourth manager at the beginning of April so increasing the theme weighting to 22.25%.

Global Financial Sector Dislocation lost money. We have submitted redemption notices for two of the three managers in the theme. In one case, this followed a change in key personnel. The second fund has maintained an exposure to small and midsized US Banks expecting weakness in their loan books to be reflected in stock price weakness. It is a perfectly logical expedient for the FDIC to broker deals for the absorption of failing Banks into less vulnerable neighbours. However, the timing of these moves is hard to forecast and shareholders often get a premium for their co-operation. This makes for a treacherous and unappealing investment environment for a manager with a short bias.

At the theme level, a solid positive return in February came from Credit Spreads in Transition, where our five managers each produced gains for the second month in succession, but in more challenging conditions. Credit markets reversed direction in mid February and High Yield Mutual Funds saw net outflows. The volatility of daily returns in High Yield has climbed fourfold since December. In the US, $300bn of securities at face value has been purged from the sector by restructurings and bankruptcies since the start of 2008, compared with $125bn at the peak of the last default cycle in 2001/2. But returns in the past year exceed those from the start of the last decade. So we may well have arrived at the point where the credit pickers prevail, getting paid for their ability to master the more awkward propositions.

Energy Market Opportunities produced a tiny gain while the Asian Consumer Power theme was neutral. Much effort is being expended on the selection of the letter of the alphabet that best describes the profile of the recovery commentators hope that the Global Economy is going to experience. Rather than a ‘U’ or a ‘W’, those positive on Asia are forecasting a ‘K’. The upstroke of the K depicts the trajectory that Asian growth will take. The down stroke reflects the outlook for the rest of us. In the event that there is no one to export to, Asian economies will need to make continuing adjustments to the balance of their economies and the role of domestic consumption will need to expand. But there is still a case for the ‘K’. The Government elected last year in India presented its first budget during February. India does not have the same reliance on exports as some of its regional neighbours, but it does have fiscal challenges, reflected in a projected 5.5% Budget deficit/GDP ratio. It also needs to continue structural reforms. Both priorities were reflected in the proposals tabled.

Two themes held the performance back. The weighting allocated to Global Financial Sector Dislocation is in the course of being reduced by a quarter and the number of managers reduced to two. In 2009, 140 US Banks closed; 20 more have closed this year and there are over 700 on the FDIC list of institutions at risk. Yet continuing weakness in the fundamental picture is not reflected in the valuation of bank stocks as the financials continue to outperform broader stock indices.

The role of politics in markets grew during February, but it did so without specific proposals for additional regulation. Talk of Sovereign CDS bans has alarmed participants to the point where, for the time being, the market in Greek risk has ceased to function as a liquid market. US Taxpayers might well ask why banning these instruments was not considered before they spent $170bn bailing out AIG, one of the leading actors in the CDS drama. The managers in the Relative Sovereign Opportunities theme produced mixed results individually, but a small loss in aggregate.

In January, asset markets began to question the vigour and durability of the liquidity driven post-crash bounce. In this context, the result for the month was solid. Five themes produced positive returns; the Asian theme lost money. Below is a brief update on the rationale for each of our themes.

All five managers in Credit Spreads in Transition were profitable and, given its 39% portfolio weighting, this produced over half of the return. The post-crisis tightening of credit spreads is over and an uneven path for spreads is in prospect from here. The US default cycle may well have peaked in December, but the looming overhang of corporate refinancing through to the end of 2012 looks like providing a continuing supply of highly stressed credit for some time to come.

Japan Corporate Event Opportunities is made up of two managers, one of which will be redeemed as of March 1st. This will reduce the weighting to 5%. Most non-Japanese investors have given up at this point and a 5% commitment cannot be described as a ringing endorsement of the case for Japan. However, this manager is seeking opportunities arising out of the widespread international neglect of Japanese equity investments. His success does not depend on political reform or economic regeneration and his presence in the portfolio will help us track developments.

Our Relative Sovereign Opportunities thesis is being played out in the nightly television news bulletins. Greek credit is weak, but others are frail, especially in the industrialised west. Politicians can draw satisfaction from the co-ordinated nature of the stimulus measures introduced to counter the financial crisis in 2008/9. However, stimulus withdrawal cannot be synchronised. Not only do growth rates vary between countries, but so do borrowing requirements, average debt maturities, the tax base and the role of domestic savers compared with foreign investors in providing new finance. Credit spreads, interest rates, yield curves and currency values can be expected to reflect the perceived variations in national and regional performance for as long as those differences grow.

Global Financial Sector Dislocation is a theme with a defensive dimension. Circumstances have been created that support big bank profitability despite limp loan growth and stubborn credit losses. We believe that the banks and insurers still face wrenching change and that our specialist managers can get ahead of the market in recognising its impact.

The energy industry is global. Yet, many of its participants are listed on national equity markets where local valuation drivers overshadow the wider picture and thus create anomalies which our Energy Market Opportunities managers are out to capture. In addition, energy pricing is a major macro input and a key agent for change in financial market valuations. Recognising its significance, on February 1st, we added an energy trading manager.

Our longstanding Asian Consumer Power theme reflects the view that its fundamental strengths will continue to show through in higher rates of growth than elsewhere, and that the region is at a stage in its growth trajectory when local consumption will account for a rising share of GDP, providing impetus to the trend.

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.

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 and the Culross H Fund have received awards as a top ranked Fund of Funds based on its 3 year performance by Portfolio Adviser magazine.

Methodology

Using data from Morningstar – a database of over 4,000 Fund of Funds, Portfolio Adviser took the top 10 ranked Funds and presented them to the judging panel.

The judges were then asked to nominate 3 Funds where they would invest their own money as well as that of their clients if investing today. Portfolio Adviser collated these results, awarding one Winner and 2 Highly Commended.

• The Culross Global Fund was announced as the overall winner.
• The Culross H Fund received a highly commended.

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.

The two themes with the largest weightings in the portfolio, Credit Spreads in Transition and Relative Sovereign Opportunities themes did well in October. Global Financial Sector Dislocation and Asian Consumer Power both lost money. We added two managers. One is a Japan equity specialist with a unique approach, well attuned to a market environment which is inefficient because hardly anyone is active in it. The second is a global credit manager with a strong grasp of valuation relationships within credit.

The Relative Sovereign Opportunities theme is made up of three managers focussed on the macro trends playing out in today’s investment environment. Between them, they cover a wide range of geographies. The 08/09 financial market crisis and its aftermath dominate the economic agenda everywhere, but the impact is different. All the developed (and other over leveraged) economies have loaded future taxpayers with the cost of bailing out their banks, added to the burden of fiscal stimulus. They differ in the debt levels they started out with, the economic health of their tax base, their demographics and the extent to which they can fund their borrowings in their own currencies, but in general, the old G7 countries have weaker public finances than the leaders of the emerging world. Their future growth will suffer as a result and when it comes to competing for capital in future, some of them will find it hard to measure up.

The region best able to shake off the negative effects of the financial crisis is Asia. Asian Consumer Power is a durable theme in our portfolio and generated a third of the aggregate result for September. The strengths of the region in terms of demographics, education, work ethics and saving rates are well documented. China is the most obvious, but by no means the only example of the strength of the public finances of many of the countries in the region. This has never been more significant as its fiscal strength allows the big population, low income countries to lead Asia out of its cyclical slowdown, with stimulus programmes particularly targeted at infrastructure spending. Most Asian consumers have suffered none of the balance sheet damage meted out to their over leveraged real estate investing fellows in the West and the economies of the region are back on the path of GDP growth. All four of the managers in the theme were profitable in the month.

Credit Spreads in Transition also generated a third of the Fund’s September return. Our two managers have modified their portfolios markedly in the past three months. The big tightening in spreads provided good opportunities in performing credits that were far too cheap. As this phase has concluded with these spreads normalising, the managers have begun to position more defensively for the next phase. Remaining High Yield positions can be hedged with CDS or, now that they are more fully valued, equity shorts. The S&P index of defaults in leveraged loans hit an all time high in September, symptomatic of an increase in the flow of opportunities in distressed securities. The valuation of these is driven by idiosyncratic factors and not by spread indices. Where there is Debtor in Possession financing involved, it is both ‘super senior’ and done on floating rates. Finally, one of our managers has built a position in distressed residential mortgage bonds. The skills required to master broken structured mortgage credit are not taught at high school. But that is good news for those equipped to sift through the wreckage and understand what they are looking at.