NOTE: This is not David Einhorn’s Q2 or Q3 letter. This is for a different fund, and I am pleased to present it for your reading pleasure. This is an interesting letter, and reveals some info I never knew about. I will try to embed this document in scribd for easier reading:

I will be posting a very exciting shareholder letter from another famous value hedge fund tomorrow. Stay tuned….

Dear Partner,

Greenlight Masters Qualified, L.P., Greenlight Masters, L.P. and Greenlight Masters Offshore returned 0.1%, 0.0% and 0.1% respectively for the first half of 2011, net of fees and expenses.1 For the same period, the S&P 500 returned 6.0%. The flat performance in a rising market was the result of Masters’ cautious net exposure and losses in some of our managers’
short portfolios. The funds’ average net long exposure for the period was about 41%.

One of the prevalent themes we have encountered this year in our conversations and meetings with Masters’ managers is the challenge of running a long/short equity program in a market where rising valuations are not supported by underlying business and economic fundamentals.
While it is inherently difficult to find cheap, attractive longs in overly bullish markets, it can be equally difficult to manage short positions because near term market enthusiasm can test a short seller’s long term conviction. Though longs that move against you become smaller positions and may present opportunities to add, shorts that move against you become larger positions and might force covering for risk management purposes, even if the short thesis remains intact or has improved.

Though many investors might be inclined to ride a rising market, Masters’ managers have collectively done the opposite. From the beginning of 2010 to the midpoint of 2011, while the S&P 500 was up 22%, Masters’ net exposure has come down from about 51% to 38%. With our managers making position by position decisions based on fundamentals and valuation, the collective Masters portfolio has lower exposure due to what our managers view as a less attractive opportunity set. Our managers have also built dry powder to take advantage of market dislocations, such as the one that is in progress as we write this letter.

In absolute terms, our six largest managers in the first half of 2011 had a positive contribution from longs, while Firefly and JMB also had a positive contribution from shorts. Masters’ overall net exposure has remained modest, although this aggregate look-through exposure is comprised of a wide range of positioning among our managers’ portfolios. All of our managers continue to search for opportunities based on bottom-up, fundamental analysis and
valuation, while also weighing macro considerations. Some ways in which our managers incorporate their macro views into their portfolios include gross and net exposures, cash levels, positions in commodities and use of derivatives.

 

The table below offers a snapshot of performance attribution of Masters’ six largest weightings and exposures as of June 30, 2011.

Performance and Attribution for January-June 20112

Performance Attribution3 Net June 30 Exposure
Longs Shorts Return Long Short Net
Greenlight Capital 6.8% -10.9% -5.1% 101% 76% 25%

Firefly 1.9% 4.1% 3.7% 99% 54% 45%

JMB 2.8% 1.4% 3.3% 65% 19% 46%

Pershing Square 4.0% -2.8% 0.3% 87% 6% 81%

Third Point 7.7% -0.9% 6.8% 104% 48% 56%

Valinor 5.7% -4.5% -0.6% 130% 58% 72%

As an example of our managers’ flexible opportunism, Third Point has shown its broad based skill set this year by achieving positive returns in both equities and credit (including distressed debt and mortgage securities). Total net performance so far this year is 6.8%, which includes 3.5% from equities and 3.0% from credit. Third Point has also been our most dynamic manager in 2011 in terms of adjusting its portfolio positioning.

At the start of the year, Third Point was 121% long, 19% short and 102% net. By the end of Q2, Third Point had brought exposures down to 104% long, 48% short and 56% net. The net exposure included more than 30% in equities and more than 20% in credit. Recent exposures have come down further in the August market dislocation, and Third Point is now 87% long, 42% short, and 45% net overall – with only 12% net long equity exposure. In a recent letter to
investors, Portfolio Manager Dan Loeb offered the following commentary:

Generally, we are “bottom up investors.” However we are living in a climate
where…economic and political considerations are at least as – if not more –
important than underlying fundamentals in forecasting investment outcomes.
Given the great uncertainty…and sentiment levels that reflect it, I can foresee
scenarios where securities could trade much higher – or much lower. …We
reduced our net exposures throughout the second quarter. Beginning in April,
we concluded that the equity market no longer offered compelling upside…
Notwithstanding our continued cautious outlook, we have a number of
significantly sized event driven positions which we are confident have upside
drivers regardless of the macro environment.

2 Managers shown here include Greenlight Capital and the next five largest weightings in alphabetical order.

3 Performance attribution may not reconcile to net performance due to fees, expenses and other portfolio gains and losses.

Third Point has continued to strengthen its team this year, adding six investment professionals, bringing the total to 21. These latest additions include the return of former analyst and portfolio manager Munib Islam, who has rejoined Third Point as Head of Equities Research. Third Point is currently closed to new capital.

Some of our managers reflect their macro views through exposures while others take a more agnostic view, reflected in part by more consistent portfolio characteristics. Firefly, for example, has consistently been invested approximately 90-100% long, 50-60% short and 35 45% net. In the first half of 2011, Firefly’s disciplined, bottom-up program has been notably
distinguished by profits from short positions, where it reported a return on invested capital of
about 8% despite the market’s rise. Firefly has had success in particular from its focus on
finding “terminal” shorts – i.e., situations where it believes the equity ultimately has no value.
Some examples in this category have included companies who are weakly positioned in
industries going through significant technological change, such as advertising, photography
and books.

In a recent conversation with Co-Portfolio Manager Ariel Warszawski, he offered some color
on Firefly’s investment program in today’s difficult environment. “Shorting eventual ‘zeroes’
can be a painful game in the short term,” Ariel said. “The volatility can be distracting, so you
need good research, careful risk management and good stock loan partners.” He also
emphasized the importance of having investors who understand the firm’s strategy and have a
long time horizon. A seed deal for Masters,4 Firefly just had its fourth anniversary, manages
more than $450 million and has grown to five investment professionals and four operations
personnel.

In late spring, we visited five of our managers with offices in California. We met with Hylas,
JMB, Lonestar, Philadelphia Financial and Route One Investment Company.

Masters invested with Hylas, another seed deal,4 in September 2010. Since that time, Hylas
has returned about 28% for Masters, with average net exposure of about 36%. For that same
period, the S&P 500 has also returned 28%, meaning Hylas has generated alpha of about
17%. In 2011, Hylas is up over 7% for Masters through the end of June, earning 15% on
longs and losing 6% on shorts.

We met with Hylas Director of Research August Roth and reviewed multiple investment
ideas, as well as latest business developments and plans. From our conversation with August,
we continue to be impressed with Hylas’ research process, which is focused on companies
undergoing significant balance sheet changes. They describe their process as looking for
“credit-focused equities” and “equity-focused credits.” So far in 2011, key longs have
included an oil refiner rationalizing assets and reducing debt,

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