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 To: Viking InvestorsFrom: O. Andreas HalvorsenDate: January 9, 2009Viking’s objective is to achieve maximum capital appreciation commensurate withreasonable risk. We began positioning the portfolio more conservatively to preservecapital in 2007 due to heightened counterparty risks and deterioration in market liquidityand did so increasingly in 2008 as we became concerned about the unpredictable natureof government and regulatory actions as well. As a result, we are in a strong position totake advantage of future opportunities. I will expand on this topic in this letter as well asdiscuss a pending personnel change: Dan Cahill, our President, intends to transition to anAdvisory Director over the course of 2009 in order to spend more time with his family.
Performance and Portfolio
Our performance net of all fees on a composite
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basis was flat in the fourth quartercompared to a loss of 20.6% for the MSCI World Index and a loss of 21.9% for the S&P500 Index. For the full year, our performance net of all fees on a composite
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basis was apositive 0.1% compared to a loss of 38.7% for the MSCI World Index and a loss of 37.0% for the S&P 500 Index.
VGEMSCI World IndexS&P 500 Index
Net Return
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Fourth Quarter0.0%-20.6%-21.9%Full Year0.1%-38.7%-37.0%
Annualized Volatility
Fourth Quarter15.7%55.3%67.9%Full Year11.5%31.9%40.9%
 I believe our outperformance relative to the market in 2008 was primarily due to twofactors: (1) disciplined stock-picking which led to alpha generation and lower net
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Viking composite return is the weighted average of investor returns across all Vikinghedge fund products (VGE LP, VGE II LP and VGE III) assuming investors are subjectto a 1.5% management fee and a 20% incentive fee taken at calendar year-end. Actualinvestor returns will vary based on fund, class, hot issue eligibility, and timing of individual contributions and withdrawals. The attached Performance Report providesfurther details by fund, class, and hot issue eligibility.
 
exposure, and (2) significantly reduced gross exposure which gave us the flexibility tocontinue our stock-picking throughout the year rather than put us on the defensive.
(1) Stock-Picking
The desired output of our analytical effort is a positive spread between theunlevered performance of our longs and the unlevered performance of our shorts.For the fourth quarter, our longs were down 7.8% and our shorts were down21.7% yielding a positive 13.9% spread on an unlevered basis. For the year, ourlongs were down 23.9% and our shorts were down 42.4% yielding a positive18.5% spread on an unlevered basis (see the attached Base Case Analyses).Our new investment structure served us well and, in my view, was one of thereasons behind the strong relative performance in 2008. In part, the goodperformance of our largest positions came as a result of the strong alignment of incentives on the investment staff. Analysts are now 100% focused on the Vikingportfolio, rather than individual sub-portfolios. Our investment team has neverbeen stronger.Running a low net exposure served us well in the past year. The benefit can besplit in two: (1) the component arising from our Base Case practice of employing40% net exposure and (2) the component arising from our actual net exposurebeing lower than the Base Case in the fourth quarter and for the year as a whole.By definition, a fund that runs 40% net will be advantaged in down markets (andsimilarly disadvantaged in strong markets). For example, if the market is down40% in a particular year, a hedge fund with 40% net exposure would be down16% as a starting point and hence outperform the market by 24 percentage pointswithout any benefit accruing from superior stock-picking. Our net exposure of 19% on average in the fourth quarter and 30% on average for the year benefitedperformance by a further 5.2% and 3.8%, respectively, relative to the Base Case.We do not actively manage our net exposure. Each position in the portfolio, longand short, is sized according to its relative attractiveness. Therefore, net exposureis an outcome of the portfolio construction process. Given our strong belief in theintegrity of our investment selection process, we do not second-guess the resultingnet exposure based on top-down analysis. To the extent we have macro-relatedviews, they are formed by our company-specific research and typicallycorrespond with our bottom-up portfolio construction. Sticking to our businessmodel led us to a lower net exposure which benefited performance in the fourthquarter and for the year.
(2) Reduced Gross Exposure
We do actively manage our gross exposure, which steadily dropped from 196% inJuly 2007 to an all-time low of 70% in November 2008. Viking’s gross exposureon December 31, 2008 was 91% comprised of 57% long and 34% short for a net2
 
long exposure of 23% and a long/short ratio of 1.7x. At 91%, our year-end grossexposure was well below our typical range of 150-210% and appropriatelyreflected our conservative stance and emphasis on capital preservation. We werenever forced to reduce leverage, but deliberately took down risk for reasons Idiscussed at our Annual Meeting and in the third quarter letter. Instead of recapping what I have already said, attached is an email Dave Ott sent to “AllVikings” in October that you may find of interest. This email gives a realisticpicture of our outlook following lengthy deliberations about the state of affairslast summer and early fall. Over the past two months, we have slowly increasedgross exposure and expect to continue doing so at a rate resembling the gradualdecrease over the prior fifteen months. The factors that led us to reduce grossexposure are all moderating: government actions are more consistent andpredictable; it has been several weeks since a new, significant crisis emerged; theTED Spread (the difference between interest rates on interbank loans and short-term U.S. government debt or T-bills) is falling; and flows into prime moneymarket accounts appear to have stabilized and last month exceeded flows intoU.S. Treasuries.Given the environment in which we have been operating, we feel that we havemanaged the portfolio prudently and that the reduction in gross exposure wastimely. A result of this conservative stance was annualized daily volatility of returns well below that of the broad indices (16% for the fourth quarter versus55% and 68% for the MSCI and S&P 500 indices, respectively; 12% for the yearversus 32% and 41% for the MSCI and S&P 500 indices, respectively). Had wenot reduced gross, we would have experienced higher volatility in returns andlikely a loss of freedom to act from a position of strength, as well as a potentiallyhigher rate of redemptions than the 6.1% of external capital that was redeemed atyear-end. The most tangible benefits of our lower gross exposure are virtually nolosses on counterparty exposures due in part to limited dependence on portfoliofinancing (our active management of counterparty relationships played asignificant role too) and a content staff that remained unconcerned about Viking’shealth. Any of these factors could easily have gone against us and limited oureffectiveness as investors and risk managers. I cannot recall a single Vikinginvestor or analyst raising concern about our low gross exposure. Without theconstant pressure of managing a leveraged balance sheet in a very difficultenvironment, our investment staff showed up at work every day and did what wedo best: pick stocks and reliably produce value over time. While the merits of reducing leverage are obvious, the costs of doing it are lessso. Running at a lower gross exposure than normal actually hurt our performancegiven the positive spread between our longs and shorts. By not leveraging ourportfolio to this positive spread, we sacrificed several percentage points of returnsin the fourth quarter. To illustrate, had we kept our net exposure at 19%, theaverage during the fourth quarter, and expanded our longs and shorts to yield188% gross exposure (the average for the 2005-07 period), the fourth quarter3
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