Sandhill had a terrific quarter – our best relative to the market since the third quarter of 2013.
Sandhill’s Concentrated Equity Alpha (CEA) composite was up 5.7% (net of fees) vs. a 0.4% return for the S&P 500 Index. Sandhill provided 5.3% of excess return relative to our benchmark in the quarter, and we are pleased to execute so well for our clients.
Over the last six months, Sandhill’s CEA composite is up 12.3% vs. 4.8% for the S&P 500 Index. These returns have been achieved in a relatively conservative way – with low turnover and carrying a lot of cash.
In our ongoing goal to purchase quality assets in the public markets and deliver meaningful excess return, the last six months once again demonstrate that the exact timing of when returns on capital will “arrive” is a fruitless and meaningless exercise. When the equity market (in general) or acquirers (in particular) will recognize the “intrinsic” value of the assets we buy for our clients is unpredictable – so best to spend our time doing homework on our individual companies.
Our CEA composite track record (Global Investment Performance Standards certified) now spans more than eleven years. Over the life of the track record (3/4/04 – 3/31/15), the CEA composite has returned 158.9% (net of fees) vs. 88.7% for the S&P 500 Index. The long term track record is always the most telling.i
One of the main catalysts for performance this quarter was takeovers.
During the first quarter, two companies in the CEA composite were acquired. Our clients realized significant gains with both acquisitions.ii
The message of these takeovers (and we have had others) is that Sandhill is recognizing the value of these “franchises” well ahead of the market and/or corporate acquirers. Our clients are the beneficiaries when the value is finally realized.
The law of unintended consequences
One of the interesting by-products of these takeovers and the partial sale of some positions that have appreciated significantly (Murphy USA come to mind) is that a lot of cash has been “returned” to our clients’ portfolios. We do not mind having cash returned when asset values are high – in fact, this is the way it is supposed to work.
We have gotten a lot of questions with regard to high cash balances in our client accounts.
So…..there is a bit of a conundrum, here. The stock market has tripled in the last five years, most public assets are fully valued, and yet we have had a bunch of cash on hand.
We have had the suggestion to buy a “market” ETF while we look for suitable investments. Not a bad suggestion, but if we are having trouble finding things to buy (partially because the market is fully valued), why would one want to increase equity exposure?
One of the many things that I have learned managing money is patience. When there is nothing to do, don’t do anything. If you do, one will simply make bad investments that will not end well and unnecessarily tie up capital. There are certain things you do in life that require the patience of Job – and managing money is one of them. When it’s time to act – we will, with prudence, and decisively. In the meantime, we will carry the cash until we can find attractive investments.
The stock and bond market
There are always good investments to be made – always an opportunity somewhere. That said, the stock and bond markets are not attractive. Equities are fully priced and bonds offer very little return and value. This is a time to be very careful and to make sure that your capital is invested in quality assets.
The good news is that the U.S. economy is healthy, there is good velocity in business growth and formation, and the labor markets continue to tighten (albeit at a slow pace). All of this news is in the stock market, and any further meaningful advance will require continued acceleration of our economic growth.
The bond market is a more interesting animal. We have been hearing for a good five years how interest rates will rise. This has not been the case. The Federal Reserve really wants to increase rates, but the Fed does not quite have enough confidence in the U.S economy to do so. The Fed has become an expert at parsing words, but the bottom line is that the Fed still believes the U.S. economy is a little too tender to tap on the brakes and raise rates.
With our fixed income portfolios, we have been buyers for the past two years of six to nine year corporate bonds. This opportunity has gone away as the yield curve has flattened in the five to ten year range. This is good for our fixed income books as it means investors are paying more for the “paper” we have already bought.
So when there is very little value in the bond market (especially on the long end of the yield curve), the thing not to do is compromise on credit and reach for yield. The shift we have made is to shorten the maturity of the bonds that we are buying to the four to six year range. By doing this, we are buying bonds on the steepest part of the yield curve and getting the most return relative to maturity for the bonds that we are purchasing.
At the end of the day, we sit with strong performance, an increasingly conservative bond portfolio, and a bunch of cash on the equity side. I like our position.
Sandhill promotions and additions
Shant Goubrial has been promoted to Chief Operating Officer of Sandhill. I would like to offer my personal congratulations to Shant. Shant is the chief architect of the client experience at Sandhill and allows our firm to be “best in class” when responding to our client base. The promotion is well deserved.
Nick D’Ambrosio has been hired as Chief Compliance Officer. Nick received a JD/MBA degree from the University of Buffalo in 2014. We are pleased to have a lawyer running our compliance effort. Nick ran this year’s audit and did a terrific job.
Lisa Langley moves from the COO slot to the Head of Institutional Sales. Lisa will now devote all of her time to developing our institutional and “channel” business. Sandhill now has two national contracts where we are the sub-advisor. Meaningful assets have begun to flow through these channels.
Lauren Morreale joins Sandhill as an assistant operations officer. Lauren worked in operations at Fiserv prior to joining Sandhill.
Growth and capital allocation
As we have highlighted in recent letters, Sandhill has undergone significant growth in the last three to four years. Revenue has more than doubled in the last three years and assets under management now exceed $600 million. Yet, somehow, I feel like we are just getting started.
We now have formal capital allocation pools so we have a strong grip on the capital that we can reinvest into the business. While eager to build out our sales organization, the quality and depth of the investment team remains at the core of our operations. Each quarter we now set aside a predetermined amount of capital to grow the business. We will spent this money first and foremost on new employees to keep the talent pool and energy of the firm moving. We will also spend growth capital on sales and marketing and information technology.
As always, we thank our clients for their ongoing support and invite those of you who are not clients to visit with us and learn more about our capabilities.
My best to everyone for a long overdue spring!
Edwin M. “Tim” Johnston III
Founder | Managing Partner