Percentage Change * BHL Net Return (28.5) (19.5) (19.3) (21.3) S&P 500 with Dividends Annual Return (26.2)% (13.7)% (10.2)% (14.

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1 July 16, 2009 Period 7/1/ /31/2008 1/1/2009-6/30/2009 S&P 500 with Dividends Percentage Change * Hedge BHL Fund Gross Index Return BHL Net Return (28.5) (19.5) (19.3) (21.3) Annual Return (26.2)% (13.7)% (10.2)% (14.6)% Dear Partners: This letter marks the completion of our first year of operation. I can t tell you how much I ve enjoyed running the fund and getting know current partners, potential partners, and service providers who have all been absolutely topnotch. For our first year, the market value of our holdings, after all fees and expenses, fell 14.6%. Despite this poor absolute performance, I take some comfort in the fact that we outperformed all domestic market indexes and a majority of international indexes. Our first year was no cake walk. Since the beginning of the twentieth century, using end-of-month prices, there have been 1,314 twelve-month periods. U.S. market performance over the past year was worse than 96% of them. The 2008 fiscal year had the second lowest equity return since the Civil War. When forced to view performance on a short-term basis (especially under current conditions), it is very difficult to have consistently good absolute returns. So in a short time frame of two years or less, relative returns (compared to the S&P 500 or another broader index) should be a good measurement of our performance. However, even relative short-term results are just noise, and long-term results (not less than five years) are all that counts. Below are our four long-term performance objectives, listed from most to least important: 1. Don t lose money! 2. (Don t forget number one) 3. Sufficient after-inflation return 4. Outperform major investment alternatives * BHL Gross Return does not include any fund expenses, reimbursements or fees to the General Partner. Hedge Fund Index is calculated from the Credit Suisse/Tremont Hedge Fund Index. The above returns are unaudited, but should differ little from final audited results. Past performance is no guarantee of future results. 1

2 So far, we ve only accomplished our fourth goal. But I fully expect that over an adequate time period all four objectives will be met. HOLDINGS As shown in Table 1 below, about 14% of the portfolio is allocated to oil and gas holdings. This category includes four separate positions: common stock in one corporation, and units in three master limited partnerships. All four companies are involved in the production, development, and acquisition of oil and (primarily) natural gas properties in North America. Due to price appreciation, we recently sold a majority of one of these positions: Linn Energy, LLC. Linn Energy is a master limited partnership (MLP) that, much like a REIT, pays no taxes as long as it distributes a majority of its earnings to the limited partners. I first became aware of Linn in November of 2008 when looking for potential opportunities in the energy sector. The prices of both oil and natural gas had plummeted from their (what some would say bubble) peaks the previous summer. As the profits of many energy companies are leveraged to the price of their underlying commodity, market prices collapsed along with both oil and the economy. However, unlike typical oil production companies, most MLP s regularly hedge their exposure to oil and gas prices. This assures they will have enough cash flow to meet regular distribution payments, no matter the fluctuation in energy prices. In the case of Linn (and both of our other MLP holdings), not only did Lehman Brothers own a large stakes in the partnership, but it was counterparty to many of their oil and gas hedges. After Lehman s bankruptcy, Linn was fortunate to quickly re-hedge their contracts with other investment banks. But in Lehman s liquidation, it would be forced to sell all of its MLP holdings, which put a huge amount of pressure on Linn s market price in subsequent months. We first purchased Linn in December 2008 at a price of $ I began by initiating a small position about 1¼% of assets as the market had been extremely volatile and I hoped to continue purchasing at lower levels. Little did I know that I had miraculously timed the bottom: to this day, Linn hasn t reached prices as low as the day we purchased. This was good news for our already established position; bad news for the shares I had yet to buy. My inability to continue purchasing at prices only 5% above our initial entry is what psychologists call anchoring. I was well aware of this bias, but still let it lead me astray. In 2008, Linn s distributable cash flow (defined as the cash earnings from operations minus capital expenditures needed to maintain those earnings minus interest payments) was $319 million, or $2.80 per unit. Actual annual distributions (dividends) were $2.56. So at the time of our purchase, units of Linn Energy were yielding about 23%. Remember, this yield was virtually locked-in for two to three years due to Linn hedging all of their estimated production. Had the market price of Linn gone nowhere, I would have been content with receiving the 23% cash yield. But I didn t believe this mispricing would last that long. Based on conservative valuations of both cash flow and net asset value (what their proven oil/gas reserves would have sold for), I believed that Linn was worth between $20 and $25 per share. Despite the fact that Linn Energy turned out to be a small part of the portfolio, I can only wish that all of our investments had the same outcome. We still own a ½% position in Linn, but as of June 30, our 2

3 total return has been 74% (including those lucrative distributions). On an annualized basis, this works out to a 219% rate of return. Table 1 Portfolio Allocation and Contribution to Total Return (For the period ending June 30, 2009) Holding Percent of Assets Contribution to Performance 2009 YTD Since Inception 1. Westerfield Corporation* % + 0.8% - 1.2% 2. Berkshire Hathaway Inc % - 1.4% - 3.1% 3. Windhouse Properties Inc.* % - 0.7% - 1.4% 4. Glasgow Company* % + 2.7% - 0.6% 5. Marseille Holdings* % + 2.3% + 1.8% Oil and gas holdings % + 3.3% + 2.9% Special situations % + 3.9% - 3.7% Other holdings % - 1.9% - 7.9% Hedging operations % + 1.2% + 1.8% Cash and cash equivalents % + 0.7% + 1.0% Expenses % - 4.2% Total % + 8.5% ============= =============== % =============== For the more aesthetically inclined readers, please refer to Appendix B for a graphic representation of the above table. Berkshire Hathaway, Inc. We have owned shares in Berkshire Hathaway since the fund launched, but doubled-down on our position in late 2008 when the markets crashed. Despite the sagging market price, Warren Buffett s conglomerate is in a fantastic position both in terms of current performance and potential opportunity. Buffett has taken full advantage of the crisis by putting billions of dollars to work at very advantageous terms. The retail and financing subsidiaries of Berkshire aren t performing up to par, but are doing relatively well considering the circumstances. One advantage of Berkshire is that a large amount of earnings and investable cash come from insurance and utility operations, both of which are relatively immune to economic fluctuations. There many ways to value Berkshire Hathaway, but there is one simplistic method in particular that I favor. You can think of Berkshire as two separate piles: cash equivalents and marketable securities (equity holdings like Coca-Cola, Wells Fargo, and Proctor & Gamble), and wholly-owned subsidiaries like MidAmerican Energy and GEICO. At the end of 2008, investments totaled $78k per share. About half of this amount is funded by insurance float, but due to Berkshire s excellent insurance operations, it is safe to assume this float shouldn t decrease or have any cost over the long-term. Other subsidiaries had * Company names are fictional. Either we are still in the process of acquiring shares, or we prefer not to disclose the position for competitive reasons. 3

4 pre-tax earnings of $3.3k per share, excluding one-time gains. At a multiple of ten times pre-tax earnings (about fifteen times after-tax), these subsidiaries would be worth $33k per share. Adding the two piles together, you get a value of approximately $111k per share (versus the current trading price of about $88k). So based on these metrics, Berkshire is relatively undervalued. Keep in mind that this simple valuation is based on recession-level earnings, depressed equity prices, and does not include any profits Berkshire receives from insurance underwriting (almost $1.8k per share last year). THE MARKET I will prepare and someday my chance will come. Abraham Lincoln Although stock markets have rallied in the recent months, the world s financial woes are far from over. We need to accept the fact that after an over twenty year economic boom, the bust is going to be extremely painful (but necessary). The simplest explanation is this: when everything does well for so long, individuals, businesses, and governments become complacent. They project the most recent past into the future and stop worrying about what could go wrong. Over time, debt and excessive spending build. The longer the good times roll, the more comfortable people become, and the less action they take to prepare for the eventual downturn. The recent market rally has shown me that the public s mindset still hasn t changed. Like it has over the last quarter-century, people expect any downturn to be only momentary for the economy to rebound immediately and resume its upward march. It will eventually, but these things take time. Not preparing for the future is what got us into this mess, and we shouldn t make the same mistake again by focusing too much on our current problems. Of course, when something bad happens, you should certainly try to determine what caused the problem and take immediate steps to solve it. But as investors, now is the time to move on. Just as the farmer sows his seeds during the seven lean years, the investor should be preparing for (though not relying on) an economic recovery a few years down the road. Years, not months, as some market participants would like to believe. In the mean time, things can certainly get a lot worse. But to what extent should an investor incorporate these economic fluctuations into their investment process? This brings me to my next topic of discussion. Macroeconomics and Investing In market analysis there are no margins of safety; you are either right or wrong, and, if you are wrong, you lose money. Ben Graham & David Dodd, Security Analysis At Braewick, we take the Seth Klarman approach: invest bottom-up, but hedge top-down. Although there have been a handful of very successful macro investors, it is something that I, and most others, are not well versed in. Macro investors take a top-down view of the world, attempting to analyze economic trends and other big picture issues. Security analysis based on top-down economic views is extremely difficult, and can at times border on pure speculation. 4

5 The above quote by Graham and Dodd says it better than I can. But that s only part of the problem. Even if you re right, your views may already be priced into the market, and result in little or no profit. It s a little like sports betting: you may strongly believe that the Patriots will win the Super Bowl, but if everyone else agrees with you, you re not going to win much even if successful. In other words, you not only have to make the right call, but it has to be different than the rest of the market. It s no good bragging to your friends about winning if they all made the same bet. All the above isn t to say that security selection has no macro component. Purchasing a business, for example, carries implicit assumptions of economic views. When purchasing a discretionary retailer (like say, JCPenney), you have to make sure the margin of safety is large enough to compensate for a wide swing in unemployment and consumer spending. If you re buying an oil or steel company, the price of the underlying commodity is what ultimately determines profit. Predicting what these prices will do is a crap shoot. Again, that s why the margin of safety should account for the fact that prices could be significantly lower in the future. (In the commodity business example, that s why good management and low-cost production is the best way to go.) In an individual holding, macroeconomic factors may not be enough to threaten the entire portfolio. But if enough similar investments are made, the small risks can add up. Even a diversified portfolio with many individually cheap securities can have huge concentrations of risk. At Braewick, I try to make sure we don t have any potentially dangerous exposure to unpredictable macro factors. Since I can t predict these variables, I try to limit them whenever possible. Reducing the correlation between individual holdings is the best way to accomplish this. But again, the risks can still add up, and that s where hedging comes in. It won t solve every problem, but it can offset some of the risk exposure. A cash position can also act as an excellent hedge against market declines. Not only does it retain its pre-inflation value, but it can be used to purchase bargain-priced assets after a drop. Having dry powder and being a provider of liquidity in an economy like the current one can be a huge advantage. The costs of holding a large cash position are high inflation and opportunity cost. These can be serious costs over time, but may be worth it if it means avoiding other poor investments or taking advantage of a market crash. I d much rather lose what we could have had than what we already have. Take our current portfolio as an example. In addition to a 19% cash position, we hold 7% of the portfolio in hedges. Most of these hedges are against the overall levels of the market. (I will discuss our hedging operations in more detail in a future letter.) Although these hedges currently have a small opportunity cost, in the event of a market collapse like those in November 2008 and March of this year, they would appreciate in value and be transferred into cash to take advantage of more prevalent opportunities. So if the market declined 20% from current levels, our cash position should be 28-32% of the portfolio. I m not sure when or if this will happen, but if it does, we ll be able to take advantage of the bargains that appear. Exactly how much cash to hold is more of an art than a science. One of the biggest aspects is to be extremely disciplined and patient in purchasing securities, and not feel obligated to use the cash. In other words, it s good to be picky. Whenever I pass on an investment opportunity, I like to comfort myself with the oft-repeated dating advice: Don t worry; there are plenty of fish in the ocean. * * * 5

6 I ll end this discussion with a quote from Seth Klarman on the current market environment: (Klarman is the founder and manager of The Baupost Group, an investment fund with one of the best long-term track records in the business.) It is easy for the volatility of one s thinking to match the volatility of prevailing conditions. Time horizons have shortened even more than usual, to the point where the market s 4:00 P.M. close seems to many like a long-term commitment. To maintain a truly long-term view, investors must be willing to experience significant short-term losses; without the possibility of near-term pain, there can be no long term gain. The ability to remain an investor (and not become a day-trader or a bystander) confers an almost unprecedented advantage in this environment. The investor s problem is that this perspective will seem a curse rather than a blessing until the selloff ends and some semblance of stability is restored. ADMINISTRATIVE Next Opening The next opening for the fund is October 1. The minimum contribution for current partners is $25,000 and $100,000 for new partners. If you are interested in making a contribution, please contact me and I will provide the necessary materials. Despite the market run-up, I believe that now is a great time to invest in Braewick. In Appendix A, you will find the historic Net Asset Value of the fund. If you have any questions, please don t hesitate to contact me at (888) or max@maxcapitalcorp.com. Best regards, Max W. Olson 6

7 APPENDIX A BHL Performance History Date NAV Units 7/1/08 $ ,870 9/30/08 $ ,870 12/31/08 $ ,870 3/31/09 $ ,870 6/30/09 $ ,870 Growth of $100 invested in: S&P 500 with Dividends Hedge Fund Index BHL Net $ $ $95.00 $90.00 $85.00 $80.00 $75.00 $70.00 $ /1/ /1/2008 1/1/2009 4/1/2009 7/1/2009 $

8 25.0% APPENDIX B Portfolio Allocation and Contribution to Total Return (One-year ending 6/30/09 ) 20.0% 15.0% 10.0% 5.0% 0.0% 0% terfield Corporation West Berks kshire Hathaway Inc. Wind dhouse Properties Inc c. Glasg sgow Company Mars seille Holdings Oil and gas holdings Spec cial situations Othe er holdings Hedg ging operations Cash & cash equivalents Expe enses -2% -4% -6% -8% -10% -12% -14% -16%