FCAP.L Regulatory News (FCAP)

27 Feb 2008 16:32

FRM Credit Alpha Limited27 February 2008 FRM CREDIT ALPHA LIMITED (Incorporated in Guernsey) INTERIM UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD FROM 1 JULY 2007 TO 31 DECEMBER 2007 TABLE OF CONTENTS PAGE DIRECTORS AND OTHER INFORMATION 3-4 DIRECTORS' RESPONSIBILITY STATEMENT 5 INVESTMENT ADVISER'S REPORT 6-8 BALANCE SHEET 9 INCOME STATEMENT 10 STATEMENT OF CHANGES IN NET ASSETS 11 STATEMENT OF CASH FLOWS 12 NOTES TO THE INTERIM UNAUDITED FINANCIAL STATEMENTS 13-20 DIRECTORS AND OTHER INFORMATION DIRECTORS Peter Atkinson (Chairman) * Richard Hotchkis * Damian Johnson Andrew Duquemin (appointed 11September 2007)* * independent non-executive REGISTERED OFFICE PO Box 173 Trafalgar Court Admiral Park St. Peter Port Guernsey GY1 4HG MANAGER AND COMPANY SECRETARY FRMInvestment Management Limited PO Box 173 Trafalgar Court Admiral Park St. Peter Port Guernsey GY1 4HG INVESTMENT ADVISER Financial Risk Management Limited 15 Adam Street London WC2N 6AH IRISH LISTING SPONSOR McCann Fitzgerald Listing Services Limited Riverside One Sir John Rogerson's Quay Dublin 2 Ireland SOLICITORS Herbert Smith LLP as to English Law Exchange House Primrose Street London EC2A 2HS as to Irish Law McCann Fitzgerald Riverside One Sir John Rogerson's Quay Dublin 2 Ireland SOLICITORS Carey Olsen As to Guernsey Law PO Box 98 7 New Street St. Peter Port Guernsey GY1 4BZ REGISTRAR Capita Registrars (Guernsey) Limited 2nd Floor No 1 Le Truchot St. Peter Port Guernsey GY1 4AE DIRECTORS AND OTHER INFORMATION (continued) AUDITORS PricewaterhouseCoopers CI LLP PO Box 321 National Westminster House Le Truchot St. Peter Port Guernsey GY1 4ND ADMINISTRATOR JPMorgan Hedge Fund Services (Ireland) Limited Newenham House Northern Cross Malahide Road Dublin 17 Ireland CUSTODIAN JPMorgan Chase Bank, National Association (London Branch) 125 London Wall London EC2Y 5AJ FINANCIAL ADVISOR Winterflood Securities Limited AND CORPORATE BROKER Cannon Bridge House 25 Dowgate Hill London EC4R 2GA LENDER Citibank, N.A. 390 Greenwich Street 4th Floor New York NY 10013 DIRECTORS' RESPONSIBILITY STATEMENT The Directors are responsible for preparing financial statements for eachfinancial period which give a true and fair view, in accordance with applicableGuernsey law and International Financial Reporting Standards, of the state ofaffairs of the Company and of the profit or loss of the Company for that period.In preparing those financial statements, the Directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; • state whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements; and • prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business. The Directors confirm that they have complied with the above requirements inpreparing the financial statements. The Directors are responsible for keeping proper accounting records thatdisclose with reasonable accuracy at any time the financial position of theCompany and enable them to ensure that the financial statements comply with TheCompanies (Guernsey) Law, 1994 and The Collective Investment Schemes (Class B)Rules, 1990. They are also responsible for safeguarding the assets of theCompany and hence for taking reasonable steps for the prevention and detectionof fraud and other irregularities. The Directors are also responsible for the maintenance and integrity of thewebsite on which these financial statements can be published. Legislation in Guernsey governing the preparation and dissemination of financialstatements may differ from legislation in other jurisdictions. INVESTMENT ADVISER'S REPORT FOR THE PERIOD FROM 1 JULY 2007 TO 31 DECEMBER 2007 Performance This period has been extremely positive for FRM Credit Alpha Limited duringwhich time the company's shares have gained 9.31%. During the same period thenet asset value increased from 103.1 pence to 111.80 pence; an increase of8.44%. This return compares favourably with the returns provided by similarasset classes: for the same period the Merrill Lynch High Yield Master II Index(GBP hedged) returned -0.40%, JP Morgan Global Government Bonds (GBP Hedged)returned 12.06% and 1 month Sterling Libor returned 3.14%. This is a verypleasing result in an environment that proved extremely hostile to creditinvestments generally. Points to note include: • Most managers reported positive returns over the period • Net exposure to the credit markets averaged 45% • The portfolio as a whole was approximately 23% net short sub-prime related securities Market Environment During July the market witnessed a major re-pricing on the back of sub primefears and oversupply in the leveraged loan market. The Merrill Lynch HY MasterII dropped -3.1%, the largest fall in 5 years. Financial markets were hit by asubstantial rise in volatility, and the extremely high leverage in the systemwas under pressure as risk reduction began to take hold. Several levered credithedge funds were caught in the liquidity squeeze, with Basis Capital and Sowoodbeing the best-known of those that had to close down. Other credit relatedinstruments were also hit; the S&P/LSTA Leveraged Loan Index was down -3.35%;the previous maximum drawdown was September 2001, when it fell -1.52%. Credit markets continued to be in disarray in August. Although the MerrillLynch HY Master II returned +1.12%, high yield spreads rose 35bps, to 462bps.Given this confused backdrop hedge fund managers found it difficult to returnpositive numbers: hedges did not pay off and value positions were pushed intonegative territory. Risk reduction and deleveraging, as well as the expectationof new supply, all contributed to increased dislocation and market volatility.The announcement by President Bush on the last day of the month that homeownersin trouble would be helped, resulted in a 5% rally across mortgage relatedsecurities. Notably August saw managers in all strategies reduce net exposurelevels from around 40 % in June to 30%. In September credit spreads tightened as fears of a liquidity-driven crisisabated, largely due to the aggressive 50bps Fed Funds cut to 4.75%. The MerrillLynch HY Master II returned 2.4% as high yield and distressed bonds moved alittle higher. That said credit spreads in some sectors widened dramaticallyand some "levered carry" hedge funds continued to be under pressure, with manyreporting negative returns in spite of the market's rally. Managers expectedcontinued choppiness, and shifted exposures to senior levels of the capitalstructure in older, less levered transactions, as well as into smaller, nichecompanies which are finding financing more difficult as banks have their balancesheets squeezed. High yield indices ended October in positive territory, with the Merrill LynchHY Master II up 0.6%. However, spreads rose 17bps to close at +436bps, havingbeen as low as +381bps during the month. There were mixed messages withincredit markets: Both GDP and 3Q company data pointed to stable fundamentals, andthe month had sizable new issuance in both investment grade ($82bn) and highyield ($19bn). These deals saw strong demand and were both upsized and placedat better than anticipated levels. The loan market successfully absorbed$13.5bn 1st Lien paper by Texas Electric which was issued along with $7.5bn ofbonds, as financing for a KKR buyout. Moody's downgraded $33bn of 2006 subprime 1st lien asset backed securities, put $24bn Aaa- and Aa- rated securitieson watch, and downgraded homebuilders such as Centex, Pulte and Lennar ondisappointing results. Financials and bond insurers began to acknowledge theimpact of the credit crisis on their businesses: Citigroup, Bank of America andWashington Mutual reported significantly weaker results, with many othersadmitting to large losses from securitised products. Finally, housing startsfell in September by an astonishing 10% to a 14-year low. At month-end the Fedcut by 25bps in response to weakness in capital markets and declining investorconfidence. INVESTMENT ADVISER'S REPORT FOR THE PERIOD FROM 1 JULY 2007 TO 31 DECEMBER 2007(continued) Market Environment (continued) Credit spreads deteriorated significantly in November. The Investment Grademarket underperformed Treasuries by 270bps, its worst month on record, whilstHigh Yield spreads rose to a four year high of almost 600bps, before rallying to575bps. The Merrill Lynch HY Master II fell 2%. New issue activity in bothHigh Yield and Leveraged Loans ground to a halt. One indication of the marketdeterioration that occurred during month was that three months ago, only 20issues yielded above 13% whilst in November there were over 170. The strategyof buying any asset with a high yield, irrespective of fundamentals, no longerappealed. Investors avoided highly levered companies, both in debt and equitymarkets. Distressed names and post-reorganisation equity sold off, particularlyin consumer-related sectors. An index of Homebuilder sentiment was at itslowest point since inception in 1985. In High Yield, the Home Constructionsector fell 9% while Construction Machinery was down 6%. The estimated lossesfrom investment in sub prime mortgages ranged from $400bn to $1 trillion. Bankloans continued to suffer weakness as credit investors priced in a recession.At the same time, the amount of "fallen angel" (former investment grade debt)nearly doubled during the year, to $130bn. The final month of 2007 ended up being another tortuous one for high yieldinvestors. Though the market managed to post a positive gain of +0.29% (asmeasured by the Merrill Lynch High Yield Master II Index), this was entirelyattributable to income and average bond prices were actually down. Rising oilprices, weak economic data, deteriorating corporate earnings prospects, and themarket perception of an insufficiently accommodative Fed all combined to placefurther downward pressure on risky asset prices during December. The primaryhigh yield market remains closed to all but the highest quality issuers- onlysix new issues priced in December for a total of $1.9bn, the lowest figure sinceAugust 2002. Portfolio Our dedicated short credit manager in the hedge section of the portfoliodelivered a strong performance helped by a substantial position in the Banking &Financial sectors. A number of positions in the Home Equity Loan sector alsopaid off as fears of a consumer credit crash grew. The Credit Value section of the portfolio performed strongly. The bestperforming position is a high conviction manager in which we have holdings intheir core fund plus their concentrated special situations fund. The managerprofited from a substantial short position in the sub-prime mortgage sector.Our worst performing manager suffered from a number of unrelated events in hispost reorganisation equity book. Our core Credit Long Short managers were also profitable albeit more modestlythan Credit Value. Shorts in Emerging Markets and Investment Grade securitieswere less profitable than the High Yield positions exploited by Value managers.It seems our managers are now beginning to be rewarded for their bearish stance. Outlook We hear from many of our managers that credit has now "re-priced" to sensiblelevels, and that there are many names they find fundamentally attractive.However, they are cautious because the technical backdrop is still veryuncertain. Demand is low as High Yield mutual funds are seeing redemptions;Prime Brokers have raised margin requirements for some low quality credit hedgefunds and some credit hedge funds have been facing redemptions. Meanwhile onthe supply side, the forward calendar of debt issuance is significantly large.It seems it will take some time for this imbalance to clear but expectations arethat the issuance will ultimately get digested, with higher spreads, lessbalance sheet leverage, and more lender friendly structures including fewer PIK,Toggle and 'Cov-lite' issues. While we don't have consensus on the exact number, our Managers agree that thedefault rate will increase in 2008; bringing the market one step closer to thedistressed cycle. They are also united in a belief that the market volatilityof the past six months will continue. INVESTMENT ADVISER'S REPORT FOR THE PERIOD FROM 1 JULY 2007 TO 31 DECEMBER 2007(continued) Outlook We believe strongly that our Managers will be able to capitalize upon such ascenario. As in previous cycles, periods of stress result in reduced liquidityand investors get paid to be more discerning. It is in these environments wherethose with skills at building balanced portfolios that target both long andshort opportunities tend to perform best. Such balanced exposures are a featureof our portfolio, and despite potentially turbulent times ahead, we areconfident that our Managers will be able to weather the storm Financial Risk Management Limited Date: 12 February 2008 . BALANCE SHEET AS AT 31 DECEMBER 2007 Note US$AssetsFinancial assets at fair value through profit or loss 2(a) 172,593,691Receivable for financial assets sold 7,651Interest receivable 2(b) 41,998Prepaid expenses 32,222Cash and cash equivalents 2(c) 221,857Total assets 172,897,419 LiabilitiesLoan payable 4 5,600,000Performance fees payable 3.2 1,020,121Management fees payable 3.1 146,774Interest payable 2(b) 159,397Commitment fees payable 4 61,030Directors fees payable 3.4 42,308Administration & Custody fees payable 3.3 31,379Audit fees payable 6,706Other liabilities 696,574Total liabilities 7,764,289 Net assets 165,133,130 Represented by: Shareholders' funds and reservesShare capital 7 157,406,209Reserves 8 7,726,921Total shareholders' funds 165,133,130 Sterling Shares:Number of Shares 7 75,263,701Net Asset Value per Share 1.118 GBP The accompanying notes on pages 13 to 20 are an integral part of these interim unaudited financial statements INCOME STATEMENT FOR THE PERIOD FROM 1 JULY TO 31 DECEMBER 2007 Note US$Investment incomeInterest income 2(b) 74,583Net realised and unrealised gain on financial assets at fairvalue throughprofit or loss and foreign currency transactions 11 4,617,219Total investment income 4,691,802 ExpensesInterest expense (169,142)Administration & Custody fees 3.3 (58,611)Management fees 3.1 (621,370)Performance fees 3.2 (717,094)Commitment fees (77,426)Audit fees (33,657)Directors fees 3.4 (90,903)Legal fees (19,679)Other operating expenses (508,180)Total expenses (2,296,062) Profit for the period from operations 2,395,740 The accompanying notes on pages 13 to 20 are an integral part of these interim unaudited financial statements STATEMENT OF CHANGES IN NET ASSETS FOR THE PERIOD FROM 1 JULY 2007 TO 31DECEMBER 2007 US$ Net assets at the start of the period 94,713,332 Proceeds from issue of shares 68,024,058Net increase from share transactions 68,024,058 Profit for the period from operations 2,395,740 Net assets at the end of the period 165,133,130 The accompanying notes on pages 13 to 20 are an integral part of these interim unaudited financial statements STATEMENT OF CASH FLOWS FOR THE PERIOD FROM 1 JULY 2007 TO 31 DECEMBER 2007 US$ Cash flows from operating activities Profit for the period from operations 2,395,740 Operating activities:Increase in interest receivable and prepaid expenses (1,739)Increase in receivable for financial assets sold (7,651)Increase in liabilities and accrued expenses 1,381,729Decrease in amounts payable for investments purchased (383,177)Purchase of investments at fair value through the profit or loss (165,338,355)Sale of investments at fair value through the profit or loss 100,453,731Realised gain on investments at fair value through the profit or loss (11,268,443)Unrealised gain investments at fair value through the profit or loss (1,690,485)Net cash outflow from operating activities (74,458,650) Cash flows from financing activitiesLoan received 5,600,000Issuance of participating shares 68,024,058Net cash inflow from financing activities 73,624,058 Net decrease in cash and cash equivalents (834,592) Cash and cash equivalents at the beginning of the period 1,056,449 Cash and cash equivalents at the end of the period 221,857 Net cash flow from operating activities and financing activitiesincludes: Interest received 61,518Interest paid (9,745) The accompanying notes on pages 13 to 20 are an integral part of these interim unaudited financial statements NOTES TO THE INTERIM UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD FROM 1 JULY2007 TO 31 DECEMBER 2007 1. GENERAL INFORMATION FRM Credit Alpha Limited (the "Company"), a closed ended investment company, wasincorporated on 1 March 2007 under The Companies (Guernsey) Law, 1994, ofGuernsey with registered number 46497. The Company has three share classes thatare authorized for issue; Euro Shares, Sterling Shares and US Dollar Shares. At31 December 2007 only Sterling Shares were in issue. The Company seeks to generate significant returns over cash, with low volatilityand beta to global credit markets, when measured over a market cycle. Byinvesting in a combination of investee Funds managed by managers who adoptresearch-based value/event driven or long-short approaches, the Company believesthat volatility and peak-to-through drawdowns will be lower than those typicallydelivered by long-only approaches. The Company will seek to achieve itsobjective by investing in a portfolio of hedge funds pursuing a variety ofdifferent credit and credit-related trading strategies. In addition, the Companymay invest in a wide variety of financial instruments. The Sterling Shares are listed on the Irish Stock Exchange and traded on theInternational Bulletin Board (ITBB) of the London Stock Exchange. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The principal accounting policies applied in the preparation of financialstatements are set out below. The Company is in its first period of operationsand therefore no comparative figures are available. The accounting polices and presentation for the interim figures are consistentwith those applied in the latest audited financial statements. The Company's financial statements have been prepared in accordance withInternational Financial Reporting Standards ("IFRS"). The financial statementshave been prepared under the historical-cost convention, as modified by therevaluation of financial assets and financial liabilities held at fair valuethrough profit or loss. The preparation of financial statements in conformity with IFRS requires the useof accounting estimates. It also requires the Board of Directors to exercise itsjudgement in the process of applying the Company's accounting policies. The Balance Sheet presents assets and liabilities in increasing order ofliquidity and does not distinguish between current and non-current items. Allthe Company's assets and liabilities are held for the purpose of being traded orare expected to be traded within one period. All references to net assets throughout this document refer to net assetsattributable to holders of redeemable participating shares. (a) Financial Instruments (i) Classification In accordance with IAS 39, the Company classifies its investments as financialassets and liabilities at fair value through profit or loss. These financialassets and liabilities are classified as held for trading or designated by theBoard of Directors at fair value through profit or loss at inception. Financialassets or financial liabilities held for trading are those acquired or incurredprincipally for the purposes of selling or repurchasing in the short term orderivatives. The Company does not classify any derivatives as hedges in ahedging relationship. All investments held by the Company have been designatedby the Board of Directors as held for trading. (ii) Recognition/derecognition The Company recognises financial assets and financial liabilities at fair valuethrough profit or loss on the trade date; that is the date it commits topurchase the instruments. From this date any gains and losses arising fromchanges in fair value of the assets or liabilities are recognised. Investmentsare derecognised when the rights to receive cashflows from the investments haveexpired or the Company has transferred substantially all risks and rewards ofownership. (iii) Valuation of investments Investments in funds are valued at fair value, as determined by the Company'sindependent administrator. In determining fair value, the administrator utilisesthe valuations of the underlying funds to determine the fair NOTES TO THE INTERIM UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD FROM 1 JULY2007 TO 31 DECEMBER 2007 (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (a) Financial Instruments (continued) (iii) Valuation of investments (continued) value of its fund interests. The underlying funds-of-funds in which the Companyis invested value securities and other financial investments on a mark-to-marketor fair value basis of accounting. The estimated fair values of certain of theinvestments of the underlying investment funds may include private placementsand other securities for which prices are not readily available. These estimatedfair values are determined by the administrators of the respective underlyinginvestment funds and may not reflect amounts that could be realised uponimmediate sale, nor amounts that ultimately may be realised. Accordingly, the estimated fair values may differ significantly from the valuesthat would have been used had a ready market existed for these investments. Forward foreign exchange contracts are valued at the forward rate at the closingdate through the residual period of the contracts. Realised and unrealised gainsor losses resulting from forward foreign exchange contracts are recognised inthe Income Statement. (b) Interest income and expense Interest income and expense are recorded in the Income Statement using theeffective yield method. (c) Cash and cash equivalents Cash and cash equivalents includes deposits with original maturities of threemonths or less and include amounts held at the Company's Custodian. (d) Functional and presentation currency Items included in the Company's financial statements are measured using thecurrency of the primary economic environment in which it operates (the "functional currency"). This is US$ reflecting the denomination in whichmajority of the Company's investments are held. The financial statements arealso presented in US$. (e) Transactions and balances Foreign currency transactions are translated into the functional currency usingthe exchange rates prevailing at the dates of the transactions. Foreign exchangegains and losses resulting from the settlement of such transactions and from thetranslation at period-end exchange rates of monetary assets and liabilitiesdenominated in foreign currencies are recognised in the Income Statement. (f) Statement of cash flows The cash amount shown on the Statement of Cash Flows is the net amount reportedin the Balance Sheet as cash and cash equivalents. The indirect method has beenapplied in the preparation of the Statement of Cash Flows. 3. FEES AND EXPENSES 3.1 Management Fee The Company pays the Manager a management fee together with reimbursement ofreasonable out of pocket expenses incurred by it in the performance of itsduties. The management fee in respect of the Sterling Shares is at the rate of1% per annum of the Company's net assets attributable to the Sterling Shares(before deduction of accruals in respect of the management fee for the currentmonth and any performance fee) as at the first Business Day of each calendarmonth payable monthly in arrears. The management fee for the period wasUS$621,370 and the amount outstanding at period end was US$146,774. 3.2 Performance Fee The Company pays the Manager a performance fee if the Net Asset Value of a Shareat the end of a performance period (a) exceeds its Net Asset Value at the startof the performance period by more than the performance hurdle and (b) exceedsthe highest previously recorded Net Asset Value per Share as a the end of a NOTES TO THE INTERIM UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD FROM 1 JULY2007 TO 31 DECEMBER 2007 (continued) 3. FEES AND EXPENSES (continued) 3.2 Performance Fee (continued) performance period in respect of which a performance fee was last paid.The performance hurdle applicable in respect of a performance period is onemonth LIBOR of the currency of the corresponding Share class, compounded monthlyand is pro-rated where the performance period is greater or shorter than oneperiod. The performance period is each 12 month period ending on 30 June in eachperiod. If the performance hurdle and high water mark for a performance period are metthen a performance fee will be calculated and payable to the Manager equal to10% of the total increase in Net Asset Value per Share at the end of therelevant performance period over the performance hurdle multiplied by theweighted average number of Shares in issue at the end of the relevantperformance period. The Company's performance fees for the period wereUS$717,094 and the amount outstanding at period end was US$1,020,121. 3.3 Administration and Custodian Fee The Administrator and Custodian are entitled to receive from theCompany an aggregate annual fee equivalent to 0.07% of the Company's Net AssetValue, such fee to be payable generally pro-rata monthly in arrears, plus othertransaction costs and out of pocket expenses. The Company's administration feefor the period was US$49,921 and the amount outstanding at period end wasUS$19,899. The Company's custodian fee for the period was US$8,690 and theamount outstanding at period end was US$11,480. 3.4 Directors' fees Each Director (other than the Chairman) is entitled to receive a fee from theCompany at such rate as may be determined in accordance with the Articles ofAssociation. The current fees are GBP20,000 per annum for each Director andGBP25,000 for the Chairman. All of the Directors are entitled to be paid allreasonable expenses properly incurred by them in attending general meetings,board or committee meetings or otherwise in connection with the performance oftheir duties. Directors earned US$90,903 during the period and the amountoutstanding at the period end was US$42,308. 4. BORROWING As and when required for operational reasons, including, withoutlimitation, for managing cash flow, settling foreign exchange transactions,funding conversions and taking advantage of short-term investment opportunities,the Company may borrow money, provide leverage and give guarantees, andmortgage, pledge or charge all or part of its property or assets as security forany liability or obligation. Any leverage which arises in the Company is notintended to be permanent and will be repaid over a short time frame. Suchborrowing is subject always to the availability of a credit line facility onsuch terms as the Directors deem acceptable in their sole and absolutediscretion. In aggregate, therefore, the total borrowings of the Company will notexceed 35% of the Net Asset Value at the point of drawdown. At 31 December 2007, the Company had entered into a credit agreementdated 27 March 2007 with Citibank N.A. as Lender ("Lender"), which allows up toa maximum of US$35,000,000 to be borrowed. Interest accrues at an annualvariable rate of 5.59% per annum. In addition, a commitment fee shall accrue ata rate of 0.25% per annum. The maturity date of the credit facility is 25 March2008. US$5,600,000 had been drawn down at 31 December 2007, being 3.35% of thenet asset value. 5. RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS The Company's investment activities expose it to various types of risk taken bythe Company and the managers of the underlying funds, which are associated withthe financial instruments and markets in which they invest. The followingsummary is not intended to be a comprehensive list of all risks and investorsshould refer to the Prospectus for a more detailed discussion of the risksinherent to investing in the Company. These risks apply to each class of Sharesin varying degrees. Interest rate risk The Company by virtue of its borrowing facility can be directly exposed tointerest rate risks when this facility is in use. In practice, whilst borrowingis constrained by the offering memorandum to be less than 35% of the net assetvalue of the Company, it is unlikely that borrowing levels of more than 10% ofNet Asset Value will occur for any sustained period. The borrowing facility forthe fund is a floating rate facility referenced to US NOTES TO THE INTERIM UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD FROM 1 JULY2007 TO 31 DECEMBER 2007 (continued) 5. RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS (continued) Interest rate risk (continued) Dollar LIBOR and as such a 1% increase in the LIBOR rate could potentiallydetract up to 0.35% per annum from the gross returns of the portfolio in theextreme scenario that the facility was fully utilised throughout the financialperiod. In practice the returns of the Company's underlying investments are, forthe most part likely to be positively correlated with LIBOR and as such it islikely that the increase in the returns of the investments will more than offsettheir increased borrowing costs over the long term, thereby neutralising anylong term interest rate risk. It is however possible that underlying investments within the portfolio willincur interest rate risk as an intentional or unintentional part of theirinvestment strategies. Market risk The Company is not directly exposed to any markets risks. However, theunderlying managers that the Company invests in may take exposure to a widerange of market factors including equity, credit, FX, interest rate, emergingand commodity markets. Additionally they may make use of complex derivativeinstruments to take and manage these exposures. FRM analysts monitor theunderlying managers on a continuing basis on behalf of the Company to ensurethat managers have the correct operational controls, systems and skills tomanage these risks. Additionally, FRM has an automated fund performanceexception reporting process to identify funds that are performing out of linewith expectations (which will include relative analysis to their historic trackrecord and their peer group). Exceptions are discussed at a monthly meeting withthe Chief Investment Officer and recorded by the risk team. Market risks at the funds of funds portfolio level are controlled via the use ofdiversification across a wide range of Hedge Fund styles and holdings. Thisdiversification is monitored and controlled via the use of a Value at Risk (VAR)system. This system uses a proprietary methodology to estimate the monthly lossthat will happen one month in twenty using the current portfolio holdings. Themethodology takes into account underlying funds with short track records andplaces greater weight on more recent information to ensure that the estimatesare representative of current conditions. The VAR system is also used toidentify concentrations of risk within the portfolio. These estimates are produced on a monthly basis by FRM's risk management teamand compared against a set of limits. If the actual values exceed these limitsthen deviation is discussed with the relevant portfolio manager to agree arelevant course of action. Courses of action may include reducing certainpositions, hedging certain factor exposures or changing the limit. Limits arereviewed and signed off by the Chief Investment Officier and Head of PortfolioManagement on a quarterly basis. Currently these expected maximums are set at avalue of -2%. Since inception, the actual values for the portfolio have rangedfrom -0.96% to -1.85%. As at 31 December 2007 the VAR estimate for the Company was -1.6%. Theassumptions for this calculation are as follows: The VAR at risk is calculated using a proprietary methodology, the broadcharacteristics are as follows: Using return data for the funds in each portfolio, estimates for the covariancematrix and means of returns of each fund are calculated. A maximum of five yearsdata is used in this calculation. For the covariance calculation, in the eventof less than 24 months data being available data for a fund, the covariance isestimated using strategy performance data from the FRM's Hedge Fund database. Anestimate of the mean return of each fund is also calculated, with a requirementfor at least twelve months data to be available. Again for funds with shorthistories the data is replaced with strategy estimates. Both statistics arecalculated using an exponentially smoothing methodology with a decay factor of0.97. To take into account effects such as fat tailed distributions, the VAR estimatedoes not use a normal distribution. Instead a proprietary distribution, the "theta" distribution is used. This models the fat tailed distribution of hedgefunds, whilst still accurately representing the body of the return distribution. NOTES TO THE INTERIM UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD FROM 1 JULY2007 TO 31 DECEMBER 2007 (continued) 5. RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS (continued) Market risk (continued) Limitations of the VAR methodology include the following: • The measure is a point-in-time calculation, reflecting positions asrecorded at that date, which do not necessarily reflect the risk positions heldat any other time; • That VAR is a statistical estimation and therefore it is possible thatthere could be, in any period, a greater number of days in which losses couldexceed the calculated VAR than implied by the confidence level; and • That although losses are not expected to exceed the calculated VAR on,say 95% of occasions, on the other 5% of occasion's losses will be greater andmight be substantially greater than the calculated VAR. Counterparty risk Counterparty risk represents the potential loss that the Company would incur ifthe counterparties failed to perform pursuant to the terms of their obligationsto the Company. The Company has all of its cash and cash equivalents held withits Custodian. Currency Risk The Company can be directly exposed to foreign exchange risks by virtue ofinvestments in share classes of funds that are not denominated in its basecurrency. When such investments are made, the investment manager has a policy ofhedging the capital value of such exposure using a rolling program of currencyswaps initiated on a monthly basis. In addition there is a secondary policy toadjust the hedge, where possible, for material movements in the intra-monthprofit and loss of the underlying investment. Where intra-month performance datais available for a non-base currency denominated investment, and the estimatedNet Asset Value movement of the investment exceeds 0.9% of the total net assetvalue of the fund, additional non-deliverable forwards that mature at the expiryof the relevant swap are executed to hedge these movements. In view of thispolicy, it is unlikely that the fund will be intentionally, directly exposed toany material FX risk. It is however possible that the underlying investmentswithin the portfolio will incur FX risk as an intentional or unintentional partof their investment strategies. In accordance with the Company's policy, the Investment Manager monitors theCompany's currency exposure twice a month. Liquidity risk The Company invests in alternative investment products, which can be highlyilliquid. With some hedge funds, the Company can only sell their units atcertain dates, which may occur monthly, quarterly, annually or worse. A lack ofliquidity may also result from limited trading opportunities in alternativeinvestment products. At December 31 2007, 56% of the net assets of the Company were held ininvestment funds allowing monthly withdrawals, 23% were held in investment fundsallowing quarterly withdrawals, 5% were held in investment funds allowingsemi-annual withdrawals, and 19% were held in investment funds allowingwithdrawals in periods greater than two years or on liquidation. The Company may, from time to time, invest in derivative contracts traded overthe counter, which are not traded in an organised market and may be illiquid. Asa result, the Company may not be able to liquidate quickly its investments inthese instruments at an amount close to their fair value to meet its liquidityrequirements or to respond to specific events. In accordance with the Company's policy, the Investment Manager monitors theCompany's liquidity position on a regular basis with regard to maintaining areasonable level of liquidity. Significant variation from reasonable levelswill result in notification to the board of directors. The table below analyses the Company's financial liabilities into relevantmaturity groupings based on the remaining period at the balance sheet date tothe contractual maturity date. NOTES TO THE INTERIM UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD FROM 1 JULY2007 TO 31 DECEMBER 2007 (continued) 5. RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS (continued) Liquidity risk (continued) The amounts in the table are the contractual undiscounted cashflows. Balancesdue within 12 months equal their carrying balances, as the impact of discountingis not significant. There follows a table to split the liabilities into periods of up to 1 month, 1- 3 months, 3 - 7 months and 'no stated maturity'. Up to 1 Month 1 to 3 3 to 7 No stated Maturity Months Months TotalLoan payable - - 5,600,000 - 5,600,000Interest payable 159,397 - - - 159,397Accrued expenses and other - - 2,004,892 2,004,892liabilities payable -Total Liabilities 159,397 - 5,600,000 2,004,892 7,764,289 6. TAXATION The Company has applied for and has been granted exempt status for Guernsey taxpurposes. A company that has exempt status for Guernsey tax purposes is exemptfrom Guernsey income tax under the provisions of the Income Tax (Exempt Bodies)(Guernsey) Ordinance, 1989 and is charged an annual exemption fee of £600. 7. SHARE CAPITAL The Company has an authorised share capital of a minimum of two shares and up toan unlimited number of shares of no par value. The Company has three shareclasses that are authorised for issue: Euro Shares, Sterling Shares and USDollar Shares. At 31 December 2007 only Sterling Shares were in issue. 31 December 2007 Sterling Shares Number of shares as at 30 June 2007 46,000,000Subscriptions 29,263,701Number of shares as at 31 December 2007 75,263,701 All Shares have the right to receive, in proportion to their holdings, all therevenue profits of the Company (including accumulated net income plus the net ofaccumulated realised and unrealised capital gains and accumulated realised andunrealised capital losses). Shareholders have the right to receive notice of and to attend and vote atannual and extraordinary general meetings of the Company and each holder ofShares being present in person or represented by a duly authorisedrepresentative (if a corporation) at a meeting shall upon a show of hands haveone vote. 8. RESERVES Total US$Balance at 30 June 2007 5,331,181Net realised gain on investments at fair value through profit or loss 11,268,443Unrealised loss on investments at fair value through profit or loss (1,690,485)Realised loss on foreign currency transactions (7,073,286)Unrealised gain on foreign currency transactions 2,112,547Net expenses for the period (2,221,479)Balance at 31 December 2007 7,726,921 NOTES TO THE INTERIM UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD FROM 1 JULY2007 TO 31 DECEMBER 2007 (continued) 9. RELATED PARTY TRANSACTIONS Damian Johnson, a Director of the Company, is also a director of FRM InvestmentManagement Limited (the "Manager"), see note 3.4 for details of amounts earnedby the Directors during the period. As at 31 December 2007: (a) Employees of Financial Risk Management Limited (the "Investment Adviser")held 995,600 shares in the Company; (b) FRM Holdings Limited, the parent company of the Manager and the InvestmentAdviser held 677,000 shares in the Company under the nominee name Roy NomineesLimited 22607 Account. As at 31 December 2007, Richard Hotchkis, a Director of the Company, held 30,000shares in the Company. FRM Credit Alpha held 566,998 shares in various segregated portfolios of FRMConduit Fund SPC, a fund with the same investment manager as FRM Credit Alpha(FRM Investment Management Limited (the "Manager")) at 31 December 2007. 10. EXCHANGE RATES The following exchange rates were used as at 31 December 2007 versus US Dollar: British Pound 0.5095 11. NET REALISED AND UNREALISED GAIN ON FINANCIAL ASSETS AT FAIR VALUETHROUGH PROFIT OR LOSS AND FOREIGN CURRENCY TRANSACTIONS US$Realised gain on investments at fair value through profit or loss 11,268,443, Unrealised loss on investments at fair value through profit or loss (1,690,485)Net realised and unrealised gain on investments at fair value through profit or 9,577,958loss Realised loss on foreign currency transactions (7,073,286)Unrealised gain on foreign currency transactions 2,112,547Net realised and unrealised loss on foreign currency transactions (4,960,739) Total 4,617,219 12. DISTRIBUTIONS It is the intention of the Directors that the Company should pay an annualdividend to holders of Shares of two thirds of total returns, capped at 3.5% ofyear end Net Asset Value, available as cash or scrip. Dividends will be paid outof income recognised in the Income Statement which includes realised andunrealised capital gains. There were no distributions made during the periodended 31 December 2007. NOTES TO THE INTERIM UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD FROM 1 JULY2007 TO 31 DECEMBER 2007 (continued) 13. SIGNIFICANT EVENTS DURING THE PERIOD On 31 October 2007, a final version of the prospectus was filed with the IrishStock Exchange in relation to the placing of new shares of no par value in thecapital of the Company designated as Sterling Shares, Euro Shares and DollarShares. 14. APPROVAL OF INTERIM UNAUDITED FINANCIAL STATEMENTS The interim unaudited financial statements for the period from 1 July 2007 to 31December 2007 were approved by the Board of Directors on 22 February 2008. This announcement has been issued through the Companies Announcement Service of The Irish Stock Exchange. This information is provided by RNS The company news service from the London Stock Exchange