The investment environment is unattractive.

Rapidly rising interest rates, runaway inflation, a Federal Reserve asleep at the wheel (and finally waking up), supply chains strained in every corner of the globe, and the Ukraine war is not a constructive backdrop for equities.

Two important notes – the main event is rapidly rising interest rates. I said in my January newsletter, “What inflation and interest rates do in 2022 will be the main event for the stock market.”. This remains the case.

On August 4, 2020, the ten year US Treasury had a yield of .51% or a bit better than half of a percent. Today, the yield stands at 2.91%. The yield on the ten-year Treasury is up five fold in the last year and a half. It will take time for the increased rates to work their way through the economy. The increased rates will slow down the U.S. economy.

Second, as cold as it may seem, the stock market does not care about the Russia-Ukraine conflict. It is obviously a human tragedy and a very sad event for all those who have lost their lives or had their lives ruined. What is important to the stock market is that Russia is the world’s largest exporter of wheat, has boat loads of oil, natural gas, nickel, and other vital and strategically important natural resources. While the West’s sanctions may prove painful to Russia, Russia can inflict serious pain as well. They may even have the upper hand.

All this said, my promise to our most important stakeholder – our clients, was and is to deliver a good 2022 relative to the market. You will notice our turnover (buys and sells) has declined dramatically as I cleaned up our portfolios in December and January.

I think the biggest mistake that we made was that we started “chasing” return. Through Covid, remote work, lock downs, a very expensive stock market, civil unrest in the U.S., the Ukraine conflict, rising rates, and resource scarcity, we started chasing the latest trend and/or global development in an attempt to keep up with the world. A rapidly changing world.

I stopped all of that.

We are once again making long term, thoughtful investments with strict valuation criteria. At our best, we have always been a great combination of growth and value and had the ability to spot trends, economic developments, and companies and products that will thrive in the future.

Performance

For the first quarter (1/1/22-3/31/22), Sandhill’s Concentrated Equity Alpha (CEA) composite returned -9.4% net of fees vs. a return of -5.3% for the Russell 3000 Total Return. Here is the good news. In February and March of 2022, the CEA composite was +2.2% net of fees vs. a return of +0.6% for the Russell 3000 Total Return. Although I don’t put too much credence in short term performance, our performance is now trending the right way.

For the first quarter (1/1/22-3/31/22), Sandhill’s Large Cap Yield (LCY) composite had a return of -3.0% vs. a return of -4.6% for the Dow Jones Industrial Average. Another very good quarter for LCY.

For the first quarter (1/1/22-3/31/22), Sandhill’s Corporate Bond composite returned -4.3% net of fees vs. a return of -5.1% for the Bank of America Merrill Lynch 3-5 Year Corporate Bond Index. We have no credit problems. Another really solid quarter for our bond portfolios.

For our bond holders, you can thank your lucky stars that you are not in a longer term bond portfolio. We have advocated a shorter term bond portfolio for years given the artificially low interest rates in the United States (and globally). In the first quarter of 2022 (1/1/22-3/31/22), the iShares 20+ Year Treasury Bond ETF (TLT) returned -10.6%. Losses have widened dramatically in April. TLT is down 18.6% through the close of business 4/18/22. Painful.

The other good thing about our bond portfolios is that we hold our bonds to maturity. So, as investors cash out of a mutual fund with long duration bonds, the ongoing investors of the mutual fund will share the losses of the liquidating investor. You don’t ever get rid of those realized losses. You have to pay for others liquidating at a loss. That is why we like holding individual bonds.

The private REIT we distribute and cover returned +3.7% net fees in the first quarter (1/1/22- 3/31/22). The private REIT increased its share price on 3/23/22 to $64.50 per share from $63.00 per share. Currently, they are collecting 100% rent from their tenants.

A pretty good quarter across the board. The only blemish was a bad January for CEA. I continue to be solely focused on delivering CEA performance for the year. The equity and bond markets will remain difficult and volatile.

Assets under management

I have not reported assets under management in a while. Asset growth is important because it provides scale and gives our organization positive momentum. In calendar 2021, Sandhill’s assets under management grew $264 million to $2.26 billion. The growth was a combination of new accounts and positive performance.

In the first quarter of 2022 (1/1/31-3/31/22), Sandhill’s assets under management declined $92 million – the decline in the stock market accounting for most of the decline.

Why remain in the stock market

I have painted a somewhat grim backdrop for the stock market, so why not just cash out? Here are the reasons:

1/ The stock market captures inflation. This is the most important reason for equity exposure. Think about if you had been sitting in cash for the last decade.

2/ The stock market can generate fabulous returns – but it is really difficult to predict when the returns happen. It is an utter waste of time to try and do this. Either commit to the market long term or put your money in safer investments. The trade off for receiving attractive equity returns over time is you have to put up with volatility.

3/ The stock market goes up over time. To be sure, it’s not a straight line. The Dow Jones Industrial Average bottomed at $41.22 per share in 1931. Today, the Dow is at $34,808.61 per share. That is an 844 fold increase. Tucked in that time frame are the Great Depression, one World War, the Korean War, the Vietnam War, runaway interest rates in the 1970s, the assassination of Kennedy, the resignation of Nixon, a brutal recession in the early 1980s, a 22% market drop in one day in 1987, a tech meltdown of epic proportions in 2000, a banking crisis that almost collapsed our economy in 2008-2009, and a global pandemic. Yes, an 844 fold increase.

4/ When things get difficult, that is when the bargains come. Some of our best investments that Sandhill has made have come in the trough of a severe correction or bear market.

Let’s get real

I am 61 years old. How many more cycles do I want to go through? At what point do I get more defensive?

There is an algorithm between time left to live and exposure to the equity market. This is a good algorithm to think about. When you have the luxury of time, it should be all equities.

The difficult part of the algorithm is nobody knows how long they are going to live. So, it is difficult to solve for an equation where there is one large unknown.

In my mind, two things are certain. If you have achieved your financial goals and accumulated enough wealth to live in perpetuity, then you should absolutely get more conservative. No point rerunning a race you have already won. And as you move into your fifties and early sixties and are close to achieving your financial goals, you should start to get more conservative in your asset allocation.

The bond market plays into this. Two years ago it provided almost no return and it was pretty obvious at some point the forward return would be negative. But today, you can get 3.75% or better for a good corporate bond with a five-year maturity. This is helpful for those who need income and want to be more conservative.

Wrapping up

There will be a lot of twists and turns this year. The current trend in the equity markets is down. The current trend in the bond market is down. Declining equity prices and the normalization of interest rates will be healthy for the U.S. capital markets going forward.

With regards,

Edwin M. “Tim” Johnston III Founder, Co-Managing Partner

Annualized Performance Summary (Net of Fees)

As of 03/31/2022CEA (Master)Russell 3000 TRCorp. BondB of A ML 3‐5 YearLarge Cap Yield  DJIA
1 Year‐3.1%11.9%‐3.1%‐4.7%12.0%5.1%
5 Year11.9%15.4%2.3%2.5%10.3%10.9%
10 Year12.9%14.3%3.2%2.9%
Inception10.1%10.4%

This report has been prepared for informational purposes only and is neither a solicitation to buy or sell securities. Third-party information in this report has been obtained from sources believed to be accurate; however, Sandhill makes no guarantee as to the accuracy or completeness of the information. Sandhill Investment Management (“Sandhill”) is a registered investment adviser with the Securities and Exchange Commission that is not affiliated with any parent company. Individual results may vary. Investments may not be suitable for all investors. Performance may be materially affected by market and economic conditions. Investment strategies have the potential for profit or loss. The U.S. dollar is the currency used to express performance. Performance presented net-of-fees is reduced by investment management fees, trading expenses, and administrative fees. Interest, dividends and capital gains in these Composites are not immediately reinvested. The Concentrated Equity Alpha Composite includes all discretionary non-wrap fee paying accounts in the all-cap core strategy which may hold large, mid, and small capitalization U.S. common stocks, American Depositary Receipts (A.D.R.’s), domestic ETF’s, sector ETF’s, and cash. The Russell 3000 TR Index is a market cap-weighted index of 3000 of the largest US common stocks which represents 98% of the US equity market. The Large Cap Yield Composite consists of all discretionary non- wrap fee accounts invested in U.S. common stocks, American Depositary Receipts (A.D.R.’s), domestic ETF’s, sector ETF’s, and cash in solely large capitalization companies. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.. The Corporate Bond Composite consists of all discretionary non-wrap fee paying accounts invested solely in individual Corporate Bonds and cash equivalents. The Corporate Bonds will generally be rated single B to single A and will have maturities of three to nine years. The Bank of America Merrill Lynch 3-5 year Corporate Bond Index is a subset of the Bank of America Merrill Lynch US Corporate Master Index tracking the performance of US dollar denominated corporate debt publicly issued in the US domestic market. Referenced benchmarks are not available for direct investment. For a full performance presentation and/or the Firm’s list of composite descriptions, please call 716-852-0279. Private REIT Disclosure: Accredited investors only: Non-Traded Private REIT is only offered and sold to individual investors and certain entities which are “accredited investors” under the Securities Act and the rules of the SEC, and who provide us with information we require to verify their status as accredited investors. Individuals are accredited investors only if they meet certain minimum net worth or sustained annual income thresholds. Entities are accredited investors only if they hold sufficient assets or are completely owned by accredited investors. Limited Liquidity: Investors may need to hold their shares for an indefinite period of time. Royal Oak’s share redemption program is limited in amount, may be terminated or suspended from time to time, and is only available after shares have been held for a required period of time, except upon death. In addition, Royal Oak’s ability to redeem its shares may be limited. Determined Share Value set by Royal Oak’s Independent Directors Committee: The Determined Share Value (DSV) is the price at which Royal Oak sells its common stock and is set by the members of the Independent Directors Committee of Royal Oak’s Board of Directors In setting the determined share value, the Independent Directors Committee considers, among other factors, annual valuations by an independent valuation firm, real estate appraisals and the purchase prices of recently acquired properties and tenant compliance with leases.

There may be variations from time to time in how Royal Oak’s independent directors apply or weigh the criteria in setting the “determined share value” or stock price. Royal Oak is not required by law to follow any particular methodology in setting the stock price. Distributions with respect to Royal Oak’s common stock are only made if and when declared by the Board of Directors, and are subject to state law limitations on sources of funds and Royal Oak’s ability to pay distributions and certain contractual commitments, including financial covenants. Royal Oak’s past practice of distributions does not guaranty the timing or amount of future distributions. Royal Oak’s dividend is comprised of ordinary income (taxable) and return of capital (tax deferred).