MFO FUND REPORT Fourth quarter 2015 INVESTMENT ADVISOR REVIEW 2015 could be best described as a year in which markets spent considerable time searching for direction. On the one hand, there was some improved economic data at least enough to finally convince the U.S. Federal Reserve to raise shortterm interest rates. On the other hand, there were also significant signs of stress in the energy sector, credit, and in certain markets like China. When 2015 finished, the MSCI All Country World index returned 1.8% for the year, slightly worse than the S&P 500, which was negative in price return but slightly positive (+1.4%) after including dividends. These were the worst annual returns since 2008 for the S&P 500 and 2011 for the MSCI All Country World Index. The fourth quarter was better than the year as a whole for markets, largely on the strength of a strong October, which featured a major equity rally. While the Lighthouse multistrategy funds were also positive in October, we are particularly pleased that we were also able to generate gains in November and December as volatility increased. Key drivers of MFO Diversified Fund performance over the quarter and the calendar year were: Fundamental long/short equity strategies were positive each month of the quarter, with roughly equal contribution from North America, Europe and Asia. We continue to overweight fundamental equity strategies based on the alpha opportunities we are seeing among sector and regional specialists and not based on a directional view on the equity markets. In fact, the strong alpha generation environment we have experienced led to positive performance by our Lighthouse Global Long/Short Fund in six of the eight negative months in 2015 for global stocks, as measured by the MSCI All Country World Index. Quantitative equity strategies were also positive each month during the quarter. While the backdrop for systematic strategies remains somewhat challenging, we believe that a select number of prudently riskmanaged quantitative allocations can be additive in a diversified hedge fund portfolio. Even with the relatively low beta and largely idiosyncratic positioning of our fundamental managers, we are aware that these managers can take on similar factor risks at certain times for example, leaning long growth or momentum. Adding systematic strategies to the overall equity allocation has allowed us to create what we believe is a more balanced portfolio. Given our view of these types of strategies, we initiated one new investment in the fourth quarter. Relative value arbitrage had gains driven by an optionsrelated strategy and equity hard catalyst events, particularly merger arbitrage and a large divestiture of a consumer finance company. Softer events (such as valuewithacatalyst trades) tended to produce less consistent performance in 2015, exhibited a much higher beta to the stock market, and were more susceptible to hedge fund crowding. For these reasons, we used the flexibility afforded by our structure to favor more heavily into hard events (such as mergers and other definitive capital markets transactions) rather than soft events during 2015. Fixed income registered modest profits, as managers were able to trade effectively around the U.S. Federal Reserve hike. While this allocation is still primarily agency mortgagerelated, we continue to look for new inefficiencies in the bond markets that we believe managers can exploit. To that end, we made a new investment in a municipal bond trading strategy during the quarter, which to date has been profitable. CTAs posted small losses to cap another challenging year for the strategy. Unlike 2014, when managers were able to monetize strong trends in rates and equities, 2015 was best characterized by frequent market reversals that were difficult to trade. We remain underweight CTAs and expect to remain positioned in this manner until conditions that are more favorable emerge. Credit and capital structure arbitrage posted modest losses each month of the quarter as spreads widened and liquidity remained poor. As our regular readers know, we have been underweight creditsensitive investments for quite some time and our view is that, while many assets have significantly cheapened, they may still have further to fall. Credit will become more interesting as forced sellers emerge, which should depress prices to more attractive levels.
FIRST QUARTER, 2016 OUTLOOK BY INVESTMENT ADVISOR In our view, the Federal Reserve Open Market Committee's decision to raise shortterm interest rates in December is an important step toward normalizing financial markets after years of quantitative easing. We believe the Federal Reserve is likely to proceed cautiously; yet, this change in direction after seven years of zero interest rate policy will likely have a profound impact on markets and may lead to higher levels of volatility. Certain strategies could become more challenging; however, in our view, interest rate normalization could also create better conditions for other investment strategies by removing some of the market distortions that were created by monetary policy since 2008. Stocks traded in a rangebound manner for much of 2015 something that is traditionally good for active management strategies. However, U.S. market leadership was extremely narrow with a very small number of the largest market capitalization companies in the S&P (led by the socalled "FANG" stocks of Facebook, Amazon, Netflix and Google) performing significantly better than the rest of the market. In fact, as we write this in January, the average S&P 500 stock is in bear market territory down over 20%. Our experience has been that sector specialists are better able to navigate these challenging periods when the average stock underperforms the overall market. Given this expected dynamic, we will continue to make sectorfocused equity investing the centerpiece of our equity long/short allocation. 2015 was a record year for merger activity and a profitable year for the Lighthouse multistrategy funds in our eventdriven strategies. However, we cannot recall a period in our many years of investing in which the performance differential between strategies that focus on hard events and soft events was so great. Despite this disparity, we continue to focus on hard events given the opportunity we see to make strong returns with low beta to equities. In fact, the current long market value to mergers in our multistrategy funds is roughly 80% higher than it was only nine months ago although this exposure could decline as several large deals remain on track to close during the first quarter. Recent headlines concerning creditoriented mutual funds suspending redemptions reinforce our belief that liquidity must be fully understood down to the underlying asset. In our managed accounts, we monitor what we own, and when it comes to lessliquid strategies such as credit, we need to have a higher level of conviction in the expected outcome and potential upside than would be required in a more liquid strategy. In certain cases such as liquidations, we have found investments that meet that test; however, in most cases, we believe it may still be early. For example, the yearend highyield spread of around 700 basis points is still comfortably below the peaks reached in 2011 and 200809. Meanwhile, there are other signs of bubble behavior, including the fact that covenantlite loans continue to represent a large portion of U.S. loan issuance. One comment that we hear frequently is that U.S. investors are keeping their money closer to home because the economic outlook, while far from perfect in the U.S., is more bearish elsewhere in the world. Even some of the markets that fared better last year have arguably been the beneficiaries of extraordinary intervention. For example, Japan's central bank is now the second largest owner of its stock market, after the Japanese Government Pension Investment Fund (which just recently doubled its equity allocation). Yet, our attraction to Japan and other developed markets in Asia and Europe is that they are relatively uncrowded from a hedge fund perspective. This dynamic was a significant factor in the outsized gains the Lighthouse multistrategy funds generated from outside the United States in 2015. We expect to continue to leverage our research offices in Hong Kong and London to source quality investments as we seek to exploit markets that have what we believe are greater inefficiency and less hedge fund trading. As we write this letter in January, the market has gotten off to its worst start ever for a calendar year. While we certainly have our concerns, particularly when it comes to market and geopolitical forces beyond our control, we remain comfortable with the overall risk positioning of our portfolios. As discussed above, we continue to see a number of dislocations and believe there are many attractive trades created by these inefficiencies. We remain focused on our objective of finding the best talent to exploit the opportunities created by this volatility and then constructing a hedge fund portfolio with a low correlation to traditional risk factors.
MONTHLY RETURNS (NET OF FEES) USD SERIES 1997 3.44% 2.57% 0.59% 0.45% 2.68% 1.71% 3.85% 1.01% 3.30% 0.27% 0.42% 1.79% 1998 0.43% 1.90% 2.20% 1.34% 0.13% 0.50% 0.53% 4.66% 1.44% 1.33% 2.04% 2.11% 1999 1.79% 0.21% 1.88% 3.69% 1.11% 3.28% 1.89% 0.92% 0.85% 2.29% 1.48% 0% 2000 1.91% 0.14% 0.59% 2.50% 1.65% 0.85% 0.78% 2.25% 0.32% 0.15% 5% 1.30% 2001 1.46% 0.62% 0.17% 1.66% 0.48% 0.12% 0.11% 1.10% 0.77% 0.87% 0.43% 0.28% 2002 1.23% 0.45% 0.97% 0.49% 0.45% 0.44% 0.20% 0.52% 0.11% 0.13% 0.51% 1.38% 2003 0.69% 0.41% 0.35% 1.02% 1.38% 0.55% 0.51% 0.32% 1.27% 0.73% 0.57% 0.20% 2004 1.45% 0.94% 0.67% 0.31% 1.02% 7% 0.73% 9% 0.19% 0.55% 2.06% 1.41% 2005 0.19% 1.14% 0.11% 0.50% 0.37% 1.26% 1.17% 0.97% 1.35% 2% 0.92% 1.40% 2006 1.99% 3% 0.92% 0.56% 0.43% 0.26% 0.64% 0.71% 1.31% 1.54% 1.92% 1.96% 2007 1.58% 1.02% 1.34% 1.65% 2.11% 0.87% 0.19% 2.70% 1.04% 2.75% 0.49% 0.23% 2008 2.09% 1.90% 2.53% 0.63% 1.99% 0.19% 2.78% 1.77% 6.24% 5.36% 2.74% 3.11% 2009 2.53% 0.81% 2% 0.88% 3.88% 1.14% 2.50% 2.23% 2.03% 0.67% 0.42% 1.10% 2010 3% 0.38% 1.34% 0.42% 1.59% 1.07% 1.12% 0.50% 0.83% 1.33% 0.32% 2.94% 2011 1.06% 1.42% 0.86% 1.06% 0.26% 1.17% 0.23% 2.50% 1.67% 0.62% 0.49% 0.50% 2012 1.70% 1.64% 0.73% 0.10% 1.02% 0.10% 0.75% 0.77% 0.56% 8% 0.43% 0.58% 2013 1.33% 0.39% 1.06% 0.56% 0.21% 0.47% 0.97% 2% 1.51% 1.52% 0.94% 2.73% 2014 1.56% 1.97% 0.65% 6% 0.55% 1.23% 0.38% 0.53% 0.30% 0.89% 1.79% 0.50% 2015 0.55% 1.17% 1.17% 0.31% 1.21% 1.21% 0.33% 1.20% 1.34% 1.01% 0.17% 0.80%* 21.9% 2.4% 21.1% 12.5% 4.8% 5.9% 6.4% 5.5% 8.4% 9.9% 9.5% 20.4% 19.7% 5.2% 1.4% 6.2% 11.3% 7.5% 3.0% EUR SERIES 2004 1.29% 0.92% 0.70% 6% 0.78% 0.12% 0.60% 2% 0.33% 0.47% 1.66% 1.05% 2005 2.15% 0.87% 0.12% 0.49% 0.35% 1.14% 0.99% 0.71% 1.28% 0.11% 0.78% 1.09% 2006 1.42% 0.12% 0.65% 0.30% 0.58% 0.15% 0.75% 0.44% 1.13% 1.34% 1.58% 1.70% 2007 1.41% 0.86% 1.16% 1.43% 1.96% 0.74% 0.25% 2.70% 0.96% 2.55% 0.49% 0.13% 2008 2.25% 1.87% 2.30% 0.77% 1.61% 0.40% 2.68% 1.71% 6.36% 6.78% 3.06% 2.44% 2009 3.36% 0.83% 0.46% 0.81% 4.07% 1.24% 2.50% 2.21% 2.02% 0.65% 0.41% 0.97% 2010 5% 0.33% 1.41% 0.46% 1.83% 1.12% 1.12% 0.52% 0.79% 1.29% 0.33% 2.89% 2011 1.03% 1.44% 0.86% 1.05% 0.19% 1.10% 0.32% 2.44% 1.78% 0.64% 0.50% 0.57% 2012 1.65% 1.59% 0.71% 8% 1.09% 0.13% 0.73% 0.72% 0.51% 0.12% 0.38% 0.54% 2013 1.26% 0.37% 1.03% 0.52% 0.17% 0.49% 0.88% 1% 1.45% 1.49% 0.92% 2.68% 2014 1.58% 1.90% 0.66% 6% 0.56% 1.21% 0.38% 0.51% 0.27% 0.94% 1.77% 0.46% 2015 0.54% 1.14% 1.16% 0.24% 1.21% 1.25% 0.27% 1.20% 1.40% 0.97% 0.10% 0.70%* 5.2% 9.0% 7.1% 7.9% 21.7% 20.2% 4.9% 1.3% 5.7% 10.7% 7.3% 2.4% CHF SERIES 2009 2.99% 0.78% 0.42% 0.69% 3.94% 1.25% 2.33% 2.15% 1.99% 0.57% 0.36% 1.00% 2010 2% 0.38% 1.22% 0.41% 1.83% 1.06% 1.04% 0.38% 0.74% 1.31% 0.34% 2.69% 2011 1.04% 1.36% 0.81% 0.93% 0.27% 1.19% 0.14% 2.61% 1.95% 0.53% 0.58% 0.62% 2012 1.60% 1.55% 0.69% 6% 1.12% 0.16% 0.68% 0.68% 0.49% 0.14% 0.39% 0.51% 2013 1.27% 0.31% 1.00% 0.52% 0.12% 0.48% 0.89% 1% 1.43% 1.48% 0.89% 2.63% 2014 1.55% 1.90% 0.69% 2% 0.52% 1.16% 0.36% 0.49% 0.26% 0.94% 1.76% 0.44% 2015 0.42% 1.04% 1.26% 2% 1.12% 1.33% 0.17% 1.32% 1.45% 0.91% 6% 0.80%* 19.0% 4.2% 2.5% 5.3% 10.5% 7.0% 1.6% * Estimate subject to revision NET PERFORMANCE SUMMARY MFO Diversified Fund HFR Fund of Funds MSCI World Equity Index Annualized Rate of Return 6.2% 4.6% 5.6% Annualized Standard Deviation 4.7% 6.2% 16.2% Annualized Sharpe Ratio 0.8 0.3 0.3 Worst Drawdown 20.7% 25.2% 54.6% Worst Drawdown Recovery 25 months NA 50 months Net Asset Value (NAV) <estimate> "restricted" USD 2361.41 EUR 1267.97 CHF 1236.10 ISIN "restricted" KYG6064E1109 KYG6064E1281 KYG6064E1364 Net Asset Value (NAV) <estimate> "unrestricted" USD 2369.33 EUR 1272.17 CHF 1240.27 ISIN "unrestricted" KYG6064E1448 KYG6064E1513 KYG6064E1695 Funds Under Management (mm, all Series combined) USD 174.8 MFO Diversified Fund Limited was newly formed as an offshore Fund in January 2000. All performance data above, prior to January 3, 2000, represents the returns to a limited partner in Asset Management Advisors, Inc., Diversified Investment Portfolio L.P. net of all fees and expenses applicable to a shareholder in MFO Diversified Fund Limited (calculated on a pro forma basis). Past performance is not necessarily indicative of future results. The information contained herein is neither an offer to sell nor a solicitation of an offer to purchase any securities. Such an offer will only be made to qualified investors by means of a private placement memorandum and related subscription documents.
Current Portfolio Allocation 44.0% 3.7% 2.5% 12.8% 5.6% 7.3% 4.0% 3.5% 7.9% 7.0% Cash 0.6% Fixed Income relative value 2.5% Converts 1.1% Event Driven 3.7% Long/short equity 44% Market neutral equity 12.8% Global trading 3.5% Options 4.0% Mortgages 7.0% Merger arbitrage 7.9% Distressed 7.3% Long/short credit 5.6% Cumulative Return Comparison USD Series Return Nov97 Dec15 325 300 275 250 225 200 175 150 125 100 75 Nov97 Dec99 Dec01 Dec03 Dec05 Dec07 Dec09 Dec11 Dec13 Dec15 MFO Diversified Fund HFR Fund of Funds MSCI World Equity Index 2 Years Rolling Performance vs. Risk Return 24 Month rolling windows, Jan14 Dec15 25 20 15 10 5 0 0 2 4 6 8 10 12 Risk Annualized Performance Dec97 Dec15 8.0 6.2% 6.0 5.6% 4.0 2.0 Annualized Risk Dec97 Dec15 18.0 16.2% 16.0 14.0 12.0 1 8.0 6.0 4.7% 4.0 2.0 Beta Dec97 Dec15 1.0 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.2 0.1 MFO Diversified Fund MSCI World Equity Index INVESTMENT ADVISOR TO THE FUND Lighthouse Partners is an investment management company specifically devoted to managing diversified pools of hedge funds. They currently manage in excess of $8 billion in partners capital in strategies designed to offer competitive returns within specific standard deviation and equity exposure constraints. Lighthouse has a sizeable staff of fiftythree professional employees, fifteen of whom are wholly dedicated to manager research. They have offices in New York, Chicago, Palm Beach Gardens, London and Hong Kong. Lighthouse is a combination of two important legacies: a family office pioneer in hedge fund investing and a team from a quantitative risk manager. CHARACTERISTICS Significant diversification of subadvisors Low correlation and low beta to equities LEVERAGE None OBJECTIVES 3 Year Annualized Return Target, Net of Fees: Libor + 500 bps Correlation (R2) with S&P 500: < 0.30 CURRENT STRATEGY 11 hedge funds strategies
TERMS AND CONDITIONS ORGANISATION OF THE FUND Domicile Cayman Islands Investment Manager MFO Capital Limited, British Virgin Island (a 100% subsidiary of Marcuard Family Office) Investment Advisor Lighthouse Investment Partners, LLC Offering Details According to Private Placement Memorandum dated February 15th, 2001 (revised January 2008, May 2008 and January 2009) INVESTMENT Minimum Investment USD/EUR/CHF 100'000 POLICIES Subscription Policy Monthly if received no later than 3 business days before the relevant valuation date Redemption Policy Redeemable monthly at NAV on 90 days' notice FEES Management Fee 1.5% p.a. of total capital of Fund, paid quarterly in arrears Incentive Fee None LEGAL Legal Sales Restriction for US Persons ADMINISTRATOR/REGISTRAR/TRANSFER AGENT Globe Op Financial Services (Cayman) Limited Gardenia Court, Camana Bay George Town Grand Cayman, Cayman Islands AUDITOR Pricewaterhouse Coopers P.O. Box 258 Strathvale House, George Town Cayman Islands LEGAL ADVISOR Maples and Calder Ugland House South Church Street Grand Cayman Cayman Islands MFO Capital LTD., BVI is a 100% subsidiary of Marcuard Family Office. Marcuard Family Office Telephone +41 (0) 43 344 60 00 Fax +41 (0) 43 344 60 01 www.marcuardfamilyoffice.com