Sandhill continues to deliver best in class performance.
For 2018 year to date (1/1/18-9/30/18), Sandhill’s flagship Concentrated Equity Alpha (CEA) product returned 13.9% net of fees vs. a return of 9.0% for the S&P 500 Index.
For 2018 year to date (1/1/18-9/30/18), Sandhill’s Corporate Bond product returned 0.14% net of fees vs. a return of -0.41% for the Bank of America Merrill Lynch 3-5 Year Corporate Bond Index. Sandhill’s ability to post a positive return over the first nine months of the year given the sharp rise in interest rates (and decline in bond prices) is a great result.
The power of Sandhill’s results really comes through if you look at our performance over the last two and three-quarter years.
Since the beginning of 2016 (1/1/16-9/30/18), Sandhill’s Concentrated Equity Alpha (CEA) product has returned 77.9% net of fees vs. a return of 42.6% for the S&P 500 Index. Generating excess return of 35.3% over the S&P 500 Index over the past two and three-quarter years has been a big win for our clients.
Since the beginning of 2016 (1/1/16-9/30/18), Sandhill’s Corporate Bond product has returned 10.6% net of fees vs. a return of 6.7% for the Bank of America Merrill Lynch 3-5 Year Corporate Bond Index. Another good result for our clients.
The stock market
As I have commented to many of you over the course of the year, we have been managing our clients’ capital very conservatively while still putting up best in class performance (nationally). I continue to think that caution is warranted with regard to equity investments.
Consider this (and I couldn’t believe it when I read it). Through the first six months of 2018, four stocks were responsible for 84% of the S&P 500 Index’s gain. Wow! The stocks are Amazon.com, Apple, Microsoft, and Netflix. Very thin leadership for the market centered solely on the tech sector – to me, that is a warning signal.
Now consider our Sandhill CEA portfolios. As of September 30, 2018, fifteen of the thirty-three stocks held in our portfolios have a long term gain of 50% or greater from our initial purchase price. Twenty-three of the thirty-three stocks have a gain of 20% or greater from our initial purchase price.
For investors owning ETFs or Index Funds, their return is a lot more exposed to a much smaller set of stocks than they might think. And here is the point – when those stocks run into a rough patch and everyone moves to sell the same stocks, it will be a difficult period.
Sandhill has provided a return for our equity clients well in excess of the market with better distributed gains – the best of both worlds.
Assets under management
Sandhill’s approximate assets under management as of 9/30/18 were $1.24 billion. Our assets under management have increased $197 million year to date. The asset growth is a combination of new accounts and strong performance.
Sandhill now does business in thirty-five states and continues to evolve its distribution channels.
Our new home
On June 18, 2018, we moved into our new home. I am glad that it is done! The project took thirteen months – and like anything else worth doing – it was not without fits and starts. The result is spectacular and there are many here that worked hard to make it happen.
Sandhill is now located on the top floor of the south tower of 40 Fountain Plaza. We have uninterrupted views to the west, north, and south of our beautiful city, the lake, and the Niagara River. Combined with some fabulous interior design, it’s a great place to come to work every day. We have had many visitors and encourage you to come visit us as well.
The longer I do this, the clearer it becomes that the game is won or lost at the company level. Making investments in great or soon to be great companies run by smart and creative people is where all the money is made.
But there is a second part of this equation – your equity money must be “permanent” or long term in nature to achieve success. It takes time to build great companies.
Microsoft is a simple but telling example. Microsoft went public in 1986 and closed on the first day of trading at $.10 per share. The stock closed Friday (9/29/18) at $115.35. You would have one thousand one hundred fifty-three times your money today if you purchased Microsoft on the first day of trading and still owned it. An investment of $5,000 would be worth $5.8 million.
The point is that if you were worried about what the market was going to do in the short term – at some point you probably would have sold Microsoft. Big mistake.
That said, we are due for a bear market. I can’t emphasize enough how important it is to keep a long term perspective on your equity portfolio(s).
We are nine years into our current economic expansion. The average expansion is seven years. Over the last two years, we have slowly been morphing and designing our portfolios for the next down cycle. It is important to be prepared.
The bond market arrives in time
I have encouraged clients to control risk through asset allocation. Simply, shift your portfolio more toward bonds if you want to get more conservative. Understand that stocks will handily outperform bonds over time – but the ride will not be smooth.
A funny thing happened on the way to getting more conservative – short term interest rates have increased dramatically. The bond market now offers reasonable value and meaningful return for those who want to construct a more conservative portfolio.
Many investors make simple and costly mistakes when trying to get more conservative. Many investors are told to get more diversified. Doesn’t work – most global asset classes are now highly correlated. It will make you feel better – but it won’t help if the global economies and capital markets go into a funk. If you want to be more conservative – then do so. Short term bonds are the answer. Short term bonds currently offer liquidity, price stability (capital preservation), and now a reasonable return. The bonds are a nice complement to your “permanent” equity capital.
With the rapid increase in interest rates, we can now buy five-year investment grade bonds with an average annual yield to maturity in the 4.15-4.40% range.
Holding bonds to maturity
We hold all our bonds to maturity. The only thing that we care about is the yield to maturity of the bond. That is, what is the average annual return if the bond is held to maturity? Interim performance is meaningless. The price of the bond will fluctuate (as will the return of the investment) but that does not matter unless one sells the bonds prior to maturity. Mutual funds that sell bonds at a loss to fund redemptions “lock in” those losses permanently for all fund holders. As all of Sandhill’s clients hold their stocks and bonds in their name and separate accounts, we avoid this phenomenon.
Our updated bond strategy
With the rise in interest rates and the lengthening of the economic cycle (approaching a top), I changed our bond strategy in May of 2018. Since then, we have only bought investment grade corporate bonds (with one exception – CDW bonds). In essence, I am tightening our credit policies at Sandhill at the top of the cycle. As I have said, good investors are always ahead of the curve and counter cyclical.
Our bond portfolio
Our current bond portfolio (as defined by our Corporate Bond Composite) has an average duration (effective maturity) of 3.5 years and a yield to maturity of 4.5%. By comparison, the three-year Treasury yields 2.9%. We are well positioned, and the current climate is attractive for bond purchases.
We have not had any hires or departures this year. The stability of our team is important. I can’t tell you how dedicated and talented the team is that works for you. It all starts with the results that we deliver to you – but wrapping in the service, promptness, technology, sound advice, and making it an enjoyable and fun process for all involved is important. Of the fifteen people that work at Sandhill, ten are under forty and two more are under fifty. I believe the firm and our ability to serve our clients has a bright future.
There is no short cut to good results. Discipline and execution combined with talent will continue to be our core philosophy. We are here to serve you, manage your capital responsibly, and attempt to deliver best in class results.
I hope everyone had a terrific summer.
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.