January 21, 2009

The Fund achieved a 0.03% return in December and is up an estimated 0.88% so far this
month. At the end of last month the 12-month rolling return stood at approximately 12.41% (all
figures net). The Fund’s annualized volatility is 3.34% with a Sharpe ratio of 4.451.

Last month, we profited from short volatility strategies and cash v. futures relative value
trades in the US, long UK inflation and a long Euro v. USD position. Losses came from US directional
trades, New Zealand receivers and a gold option position.

The dispersion in economic activity and inflation we noted in the December letter has become
more accentuated in recent weeks. While some economies, notably the US and Non-Japan Asia,
continues to surprise on the upside others, such as the Eurozone and Japan, are decelerating.

The difference in inflation performance is even starker (and not necessarily correlated with
current growth momentum); Japan is deep in deflation, US core inflation is set to decelerate below
1%, Eurozone inflation is steady as a rock at around 1% while UK inflation continues to move rapidly
higher. Importantly, price pressures in major emerging markets have recently accelerated and are set
to continue to increase for some time.

All of this creates a very different macro picture compared to last year. In 2009 a key theme
was high correlations between both economic and financial variables. Consequently, active
investment management was dominated by the nefarious ‘risk on – risk off’ concept. In 2010, this
‘dumb and dumber’ version of money management will no longer work as correlation break downs
will require more discerning analysis in order to navigate what promises to be choppy financial
markets.

1
12 month average of the 12 month rolling Sharpe ratio using the effective Fed Funds rate as the risk free rate.
This letter is for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instruments. All market prices, data
and other information are not warranted as to completeness or accuracy and are subject to change without notice. Prologue Capital LLP is authorised and regulated by
the Financial Services Authority.
 In the US, the recovery is largely playing out as we have discussed in prior letters. We
continue to expect the strength to continue throughout the first half of this year thanks primarily to
continued inventory lift and moderate improvements in final demand. The economy is set to begin to
create jobs over the next few months with an extra, temporary, boost coming from census workers2.
However, the key issue is not job creation per se but to what extent it will reduce the unemployment
rate. Normally at least 100,000 new jobs per month are needed to keep the unemployment rate
stable. Currently the figure is noticeably higher due to the unprecedented decrease in the
participation rate over the past year and a half. Typically the participation rate falls during recessions
because some unemployed workers get discouraged and leave the work force. As the recovery takes
hold, some of these workers return to the work force and as a result the denominator in the
unemployment rate calculation changes. Put differently, as the participation rate recovers the amount
of jobs needed to keep the unemployment rate stable increases. We assume that the participation
rate will recover a quarter of its recent decline over the next twelve months (the recovery in the
participation rate is typically slower than the decline) which means that another 100,000 jobs per
month are needed to keep the unemployment rate stable. An additional 1.6 million jobs, which
equates to 130,000 per month over a twelve month period, are needed to push down the
unemployment rate by 1 percentage point. Thus, to reduce the unemployment rate to just north of 9
percent by the end of this year requires average job growth of around 330,000 per month3, or an
increase in employment of close to 3.0%. This has happened in the past, e.g. following the 1975 and
1982 recessions when employment grew 3% during the first 10 and 11 months of job growth. But
these were the outliers, the so called classic ‘job full’ recoveries. The conclusion is that only in the
very best case scenario will unemployment drop towards 9% by the end of this year. So even in the
most optimistic scenario the US economy will have very substantial slack in the labor market
throughout 2010 and well into 2011.

The labor market slack coupled with the excess supply in housing suggests that core inflation
will decelerate during the first half of the year. Our proprietary frame work continues to point to lower
year on year rates until inflation stabilizes in the summer. Historical precedence suggests that
inflation will then stay low for some time before it gradually moves higher. As a result the Fed can
remain comfortably on hold for some time. We thus continue to view any increases in policy rates
unlikely until at least the fourth quarter. That said, we still foresee significant volatility at the end of
this quarter as several of the Federal Reserve’s non-conventional measures roll off, including the MBS
purchase program. The sell offs that may occur should be viewed as accumulation opportunities for
fixed income securities.

Turning to the UK, the inflation outlook has continued to deteriorate. Following the rapid
increase in December it is now a foregone conclusion that inflation will breach 3% in January,
requiring the Bank of England Governor to write a letter to the Chancellor. Judging by a speech
following the release of the December inflation numbers, the Governor will once again argue that the
run up in inflation is temporary. We find that argument disingenuous given the broad based nature of
the current inflation surge. Whereas the temporary increases in 2007 and 2008 were driven by certain
sectors with some remaining below the target, all major parts of the inflation basket are currently
running above the target and all of them are on an upward trend. Thus, to merely suggest as the
Governor did recently that the increase is primarily the result of the VAT increase lacks credibility.
Economic agents have already shown that they disagree by pushing up break-even inflation rates to
new cycle highs. Surveyed inflation expectations are also moving higher, albeit at a slower pace. Our
UK inflation profile, which has been accurate throughout this cycle, argues that inflation will remain
above 3% until late summer. We fully expect that to boost inflation expectations further.

The deteriorating inflation outlook and the improved economic performance make a
continuation of Quantitative Easing unlikely. At the same time, still sluggish money growth and forth-
coming fiscal tightening will delay any actual reversal of monetary policy. Nevertheless, the sum of
these factors is still a net negative for the UK fixed income market, particularly further out the curve.

2
The US government is expected to hire 1.1m census workers in the February-April period.
3
100,000 due to the usual increase in the working age population plus 100,000 due to the increase in the Labor Force
Participation Rate and 130,000 to push down the unemployment rate.
This letter is for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instruments. All market prices, data
and other information are not warranted as to completeness or accuracy and are subject to change without notice. Prologue Capital LLP is authorised and regulated by
the Financial Services Authority.
 Europe has probably seen the most significant developments since our last letter. As
opposed to the US, the economy has decelerated notably. Consumption is now 1.3% lower compared
with three months ago and new industrial orders are flat over the same period (after having grown
close to 9% just three months earlier). Note that these figures are not annualized. Fourth quarter
GDP now looks more likely to come in around 0.3% (1.2% SAAR4) compared to prior expectations of
around 0.5% (2.0% SAAR). Meanwhile, the labor market is set to deteriorate as emergency labor
market programs roll off. The inflation outlook remains stable; the base effect surge in headline
inflation is more moderate than in the US and the UK so inflation is set to remain below the target
both in short and medium term.

The Greek situation remains fluid. The government’s consolidation plan looks credible on
paper but Greek authorities have, to put it mildly, a sketchy implementation record. Although Brussels
and Athens are likely to reach an agreement during the next few weeks on what should be done, the
pressure on Greek bonds will remain until it is clear what has been done. The ECB has taken a hard
line on the collateral rules, a key issue for the Greek government and its financial system. The ECB
may decide not to revert to the old collateral rules in 2011 but even if they don’t, they are likely to
continue to talk hawkishly until the very end. Thus, the pressure on Greece should remain for at least
all of 2010. The big issue is of course how this will affect the rest of Europe. The market has clearly
become more discerning in evaluating intra European sovereign risk, punishing the credit from
governments which are perceived to have vulnerable fiscal positions. We expect this to continue for
some time. Indeed, the new normal in Europe will be a greater dispersion between government
credits which will create long lasting opportunities for active money management. Currently, our
analysis suggest that the market should price in greater risk premiums for Portuguese, Spanish and
French bonds relative to Germany, Netherlands and Ireland. Ireland, although experiencing severe
economic difficulties, has undertaken credible measures to shore up its public finances.

With the above in mind we aim to generate returns through the following strategies:

 Curve steepeners in the UK and the Eurozone.

 Curve flatteners in Canada and Australia.

 Exposure to higher UK and, to a lesser degree US break even inflation.

 Short UK duration.

 Long Eurozone and Australia against the UK and the US.

 Cross market Eurozone bond strategies that short fiscally challenged countries against
core Eurozone countries with healthier fiscal outlooks.

 Long US volatility.

 Long AUD vs. GBP and long CNY vs. USD.

 Long gold via options.

 Continued active participation in the underwriting processes of government bonds.

We are confident that the Fund is well positioned to take advantage of these opportunities
and thank you for your continued support.

Tomas Jelf
Chief Economist

4
Seasonally Adjusted Annual Rate

This letter is for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instruments. All market prices, data
and other information are not warranted as to completeness or accuracy and are subject to change without notice. Prologue Capital LLP is authorised and regulated by
the Financial Services Authority.
 Performance since Inception

Prologue Feeder Fund Ltd (main A Class)

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec YTD AUM

2006 N/A +0.60% +0.70% +1.44% +0.62% +1.26% +0.45% +0.40% +0.91% +1.12% -0.17% -0.59% +6.92% $599m

2007 +0.06% +0.51% +0.21% +0.53% 0.00% +0.83% +0.56% -1.59% +3.46% +0.49% +2.05% +0.28% +7.47% $618m

2008 +3.20% +1.20% -0.76% -0.42% +0.07% +0.45% +1.31% +1.12% +0.24% +3.78% +3.81% +3.55% +18.86% $600m

2009 +2.63% +0.81% +2.14% +0.96% +2.26% +1.29% +1.01% -0.56% +0.29% +0.35% +0.60% +0.03%* +12.41%* $927m

2010 +0.88%* $906m

Estimate*

This letter is for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instruments. All market prices, data
and other information are not warranted as to completeness or accuracy and are subject to change without notice. Prologue Capital LLP is authorised and regulated by
the Financial Services Authority.