The market was not kind to the clients of Sandhill in the fourth quarter. The market did not do well, and for the first time in a good long while, we underperformed. It was the worst December for the market since 1931 – the midst of the great Depression.
When you zoom out for the full year of 2018, Sandhill did fine. We beat the S&P 500 Index by 1.9%. This is the third year in a row that we have beaten the S&P 500 Index – something few domestic equity managers have done in our industry.
That said, at one point this summer, our Concentrated Equity Alpha (CEA) composite was up over 17% (well ahead of the market), and we finished the year down 4.3%. That is a steep decline and the loss of capital is uncomfortable (to put it mildly).
If we zoom out a little further and look at our equity performance for the last three years it is very telling:
|CEA Composite (Net of Fees)||S&P 500 Index|
|2016||+ 17.5%||+ 9.5%|
|2017||+ 33.0%||+ 19.6%|
|2018||– 4.3%||– 6.2%|
|Cumulative Compound Return||+ 49.5%||+ 22.7%|
|Average Annual Return||+ 14.4%||+ 7.0%|
While the above information might be both telling and comforting for our long-time clients (because they are compounding their capital at double digits), I more than get that clients that have come aboard this year are less than pleased. There is nothing worse than hearing our performance is good – and then losing money in your first year with Sandhill.
We have three responsibilities to our clients. First and foremost, to be responsible with their money and own good assets. We can not control the market. Second, make sure that over time all our clients make money and are well ahead of the game (and this is not a guarantee). And finally, (the reason we really get up in the morning), to meaningfully outperform the market and add real value to your life.
This said, we have money that comes to us in different “vintages” (times) – so clients’ experiences over the first few years will vary greatly. But over a longer time frame, our clients’ experiences will be very similar. I have always told new clients of Sandhill that it takes two to three years to figure out if the money manager they have hired is any good.
The one thing we will not do is take any untoward and ill-advised short-term chances (read unnecessary risk) to try and generate a quick gain in performance. That never ends well. We will stick to our knitting, remain fully invested, and continue to search for companies that we think will be worth a lot more down the road.
As I stated (rather bluntly) in my October newsletter, I remain very cautious. We may well be in a bear market. The good news is that bear markets present opportunities to own great companies at attractive prices. In addition, bear markets are normally short in duration. That said, bear markets can be severe and disheartening. Our job is to remain a steady hand and have the best line up of assets coming out of a recession/bear market.
I am neutral on the market. On the plus side, the market is at a very reasonable valuation and that will put some firm footing underneath it. On the negative side of the ledger, I think the economy, while still good, has decelerated a touch and corporate earnings growth is going to slow down – possibly a lot. This is not good for the market.
The China trade war is not really a big issue. Only 14% of the United States GDP comes from exports – and even though China is our largest trading partner – a slowdown in trade will not dramatically affect our economy. At the end of the day, China has a lot more to lose than we do -so I expect a deal that is favorable to the U.S. to be made in 2019.
The bond market
The bond market has been just as crazy (volatile) as the stock market. Interest rates rose dramatically during the year and the yield curve flattened. At the outset of 2018, the five-year Treasury had a yield of 2.2%. The yield on the five-year Treasury peaked on November 9, 2018 at 3.1% and closed the year at 2.5%. Quite the ride.
Our decision to go to investment grade only corporate bonds in May of 2018 was a good one. We tightened credit one month ahead of what may end up being the peak of the cycle. Exactly what one should do. We gorged on five-year investment grade corporates that had a yield to maturity (generally) of 4.0% to 4.5%. That window is now shut.
Given the yield curve has now flattened, we have pivoted to buying one to two-year investment grade corporate bonds. Highly liquid and safe. Today, the one-year Treasury note yields 2.60% and the five-year Treasury bond yields 2.45%. I’ll take the higher yield and shorter maturity all day long. We are currently able to buy two-year investment grade corporate bonds in the 3.40%-3.50% yield to maturity range.
We underperformed in 2018 with our Corporate Bond product. For 2018, Sandhill’s Corporate Bond composite returned -.90% vs. a return of +.38% for the Bank of America Merrill Lynch 3-5 Year Corporate Bond Index. Nothing alarming but a sub-standard year. The reason for our underperformance can be attributed to four non-investment grade (junk) credits that are in some of your bond portfolios. I am comfortable with these credits, and I intend to carry them to maturity.
As opposed to mutual funds, we carry our bonds to maturity so when we hit bumpy patches we are not forced to liquidate. This is because each client owns the bonds in their own account.
Although no guarantee, I expect our bond performance to be good if the four credits hold up. The investment grade bonds that we put on the books over the last six months should do well for our clients.
Assets under management
As of 12/31/18, Sandhill had assets under management of $1.14 billion. Our assets grew $88 million for 2018. As aggregate performance was negative, our asset growth was all from new customer business.
Additions to the team
Sandhill has hired Christian Martinez to the sales team. Christian comes to Sandhill from a regional packaging supply company where he was an important member of the sales team. Christian will be working closely with Jon Amoia.
Jenny Ly has been hired to join the operations and customer support team. Jenny recently graduated from University of Buffalo with a Bachelor of Science in Business Administration.
As I sit and write this letter this morning, the market is digesting the news of Apple’s revenue shortfall. I anticipate a bumpy ride for 2019. I welcome the volatility – for it presents opportunities that we do not often get. The important point is that we are prepared, have done our homework, and know what we want to buy should the opportunity present.
We thank everybody for their business, interest, and support.
Happy New Year!
With warm regards,
Edwin M. “Tim” Johnston III
Founder, Managing Partner
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 advisor 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 performance statistics disclosed above are calculated on the rates of return from accounts managed by Sandhill, as defined by the following. The U.S. dollar is the currency used to express performance. Composites includes discretionary accounts under management from the first full month at which the account’s capital is fully invested by Sandhill. Closed accounts are included in the composites through the completion of the last full month under management and are not removed from the historical rates of return. 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. Accounts with securities that are not part of the all-cap core strategy are not included in the composite. The S&P 500 Index is a float-adjusted market cap-weighted index of 500 of the largest US common stocks. S&P 500 Index historical performance does not represent reinvestment of dividends/capital gains or the deduction of management fees. 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 investment grade rated corporate debt publicly issued in the US domestic market. Referenced benchmarks are not available for direct investment. Prior to May 1st, 2018 these composites held both WRAP and Non-WRAP clients. This is reflected in the historical performance. For a full performance presentation and/or the Firm’s list of composite descriptions, please call 716-852-0279.