not levered to any particular economic scenario.iii)
Reflecting the bottoming of the economy, we have reduced gross short exposure and established some longpositions in businesses that are attractive in all scenarios outside of a free-fall economy.iv)
We have reduced corporate fixed income exposure and increased net equity exposure, resulting in aportfolio that is more liquid while offering attractive medium term returns.v)
We have initiated event driven positions within the equity and distressed fixed income strategies, and weexpect such opportunities to grow over the next twelve months.vi)
Our equity portfolio continues to exhibit favorable characteristics of strong operating momentum and lowvaluation (11.1x 2010 earnings, 9.6x 2011), against a backdrop of overall constructive liquidity conditions.
Third Quarter Discussion
Our performance for the quarter continued to exceed our long-term expectations with returns of more than 18%.This performance was driven by:a)
Strong performance across our equity long portfolio, including healthcare, business services and financials.b)
Continued broad strength within distressed fixed income, where security prices continue to recouple withthe relatively strong fundamentals of our underlying issuers.c)
While these gains were offset by losses in our equity short book, our reduction in gross short equitiesthroughout the quarter reduced the magnitude of such hedging losses.During the quarter, we reduced our gross short equity position to reflect our increasing confidence that an economicbottom of some form had been established based upon anecdotal commentary of a broad number of contacts across awide variety of industries. Given improving liquidity, a firmer economy and relatively low valuation levels, webelieved it was prudent to reduce our gross short book to control the risk of a significant short squeeze across mostequities. In order to contain our net exposure at reasonable levels, we also selectively trimmed our gross long equityexposure. Concurrently, we also began to reduce our gross long credit exposure as prices began to moresignificantly recouple with fundamentals in a positive manner. As a result of these actions, our gross exposure camedown approximately 25 points through the quarter, and our net exposure shifted from what was approximately a50/50 split between equity and credit strategies in the second quarter to a positioning that ended September withapproximately 3:1 exposure in favor of equity based strategies. We believe that credit’s relative attractiveness toequity most likely peaked early in Q3 09, and as such we are reallocating risk dollars to superior, risk adjustedequity opportunities.
Economic Discussion I’d Like To Buy a Vowel, Pat
Most of us have seen the popular game show “Wheel of Fortune”, in which contestants guess letters of a puzzle untilenough letters have been revealed for the contestants to solve the puzzle. While the object of the game is to earn themost money by guessing consonants that are contained in the word before solving, players may reinvest some of their prize money to buy a vowel, and with that additional information they increase their odds of correctly solvingthe puzzle.In our prior letters, we set forth our framework that liquidity and economy were the two central questions, and thatwe felt the answers to the liquidity puzzle were clear enough to base investment decisions upon. In contrast, webelieved that the answers to the economic puzzle were still highly speculative, and that three months ago we onlyknew enough to project that the economy had likely ceased its contraction, albeit for an indeterminate period of time. As such, we were willing to take on long exposure to those stocks or bonds whose securities were attractiveassuming that a bottom had been put in, regardless of the strength, length or shape of the recovery.