After a difficult start to the year, Sandhill returned to form.

We had a terrific year.

We beat our benchmarks for every product in a difficult and complex year.

We did a great job protecting our clients’ capital.

While no one gets excited about losing money, I do not believe that we have handed any of our clients permanent capital loss.

One of the most important parts of our job is to protect and preserve capital in bear markets. Numerous bubbles burst in 2022, and our clients were caught in none of them.

Our flagship Concentrated Equity Alpha (CEA) composite returned -16.9% net of fees for 2022. The Russell 3000 Total Return Index returned -19.2%.

The most impressive part of CEA’s performance is that it is a growth product and beat the broader market whose return was driven by value stocks. Growth outperforms value over time, and capital flows will return to growth when the Fed is done raising interest rates.

Our Corporate Bond composite returned -7.1% net of fees for 2022. The Bank of America Merrill Lynch 3-5 Year Corporate Bond Index returned -8.2%. The Bloomberg U.S. Aggregate Bond Index returned -13.0%. The thirty-year U.S. Treasury Bond returned -35.8%.

Sandhill’s bond performance relative to the broader bond market was really good for two reasons. First, we stayed short on the yield curve, which left us less exposed to the numerous interest rate increases from the Fed. Second, we were rock solid on credit quality.

The short duration of our bond portfolios will allow our clients to cycle out of the majority of their lower yield to maturity bond investments over the next few years and redeploy their bond capital at better rates of return. In the meantime (and investors forget this), the cash flow keeps coming every quarter with their current bond portfolios. The mark to market losses on our current bond portfolios will lessen as the bonds get closer and closer to maturity. Expect some good bond returns in 2024 and 2025. Stay patient.

Our Large Cap Yield (LCY) composite returned -8.2% net of fees for 2022. The Dow Jones Industrial Average returned -8.8%. The Large Cap Yield product is a more conservative product. The LCY companies are larger capitalization companies that tend to have lower valuations and higher yields than the companies in our CEA (growth) product. The Large Cap Yield portfolios were well managed and the place to be in 2022.

The Private REIT product that Sandhill distributes and monitors like any of our other holdings returned +7.9% net of fees in 2022. Sandhill’s clients in aggregate make Sandhill the largest investor in the REIT. With the rapid and large increases in interest rates in 2022, the REIT will be challenged financially in 2023. We do not expect the REIT to decrease its dividend, but it will likely have to pay out 110% of its Funds From Operations (FFO) in 2023 to cover the current dividend. This will not be sustainable over a long period of time. Rent increases and purchasing new properties at higher capitalization rates should allow the company to recalibrate and get back on track over the course of 2023. For the moment, I would not commit new capital here.

I do not think the bear market is over.

Most bear markets end with a capitulation – we have not had one.

The popular line of thinking now is the interest rate increases of 2022 will cause a mild recession, the Fed will stop raising rates and even cut rates, and the stock market will be off to the races.

I disagree.

I believe that our economy is much stronger than people think and the labor market will remain tight, unemployment will remain low, wage inflation will be moderate but still be a problem, and the Fed will have to raise rates more than anticipated. At that point, the stock market will crack.

And that will be the point of maximum opportunity.

Sandhill is well positioned. We are dealing from a position of strength and ahead of the curve.

We just need to be patient.

Our CEA portfolios have been cleaned up and look great. Companies with levered balance sheets or not operating well have been sold. We own high-quality growth companies at attractive prices. The growth bubble that burst in 2022 allowed us to buy the highest-quality growth companies at good valuations. Better yet, we still have a 9.6% cash position to deploy as opportunity presents.

Sandhill released our new Preferred Stock product in November. Very excited about it. A preferred stock is a complex instrument that really is a hybrid security with both stock and bond characteristics.

With the substantial rise in interest rates in 2022, there are currently attractive income-producing investments (with capital appreciation potential) open to investors that were not available a year ago. Further, I am not sure how long the window will be open.

The Preferred Stock product is a basket of 14 preferred stocks that all have qualified dividends – meaning they are taxed at the 20% federal tax rate, which is a huge advantage to taxable bonds for those in high-income tax brackets. We are currently able to buy all the securities in our portfolio at a discount to their issue and call price. The current yield on the product is 5.3%, the yield to perpetuity is 7.5% per annum (theoretical return), and the yield to call is 8.8% per annum (theoretical return). This is an actively managed product, as securities in the portfolio will be called from time to time (which we want). I do not want to give too much more away publicly – if you are interested in the product, please talk to your advisor.

We now have three great products in the fixed income asset class – our Corporate Bond portfolio, the Private REIT, and now the Preferred Stock product (which we consider a bond proxy with equity characteristics). More importantly, I think that each product is better situated for success in different rate environments – so our clients can work with their advisors to choose the best fixed income product for the current interest rate environment at the time of purchase. We have briefed our advisors on which product is best in what rate environment.

Sandhill’s assets under management and advisement at year end 2022 were $1.83 billion. Assets under management declined $431 million in 2022 because of the stock and bond market declines and net asset outflows (mostly at the beginning of the year).

We had a really good year in 2022. What I am most proud of is we were up against it and responded. The investment team gets high marks for adapting and executing in a really difficult environment and putting our clients in a really good position moving forward. We returned to capital discipline, rigor, and patience in 2022 – and it served our clients well. Expect more of the same in 2023.

I expect a bumpy and may even difficult first half of the year, a bear market bottom in 2023, and a steadying interest rate environment after a few more rate increases from the Fed. We may have a mild recession, but this does not worry me.

In this highly problematic world full of so many wonderful things and so many horrors, the United States’ capital markets remain far and away the best place to deploy capital with safety and transparency to earn a rate of return to keep pace with (or exceed) inflation, reach your financial goals, and hopefully give back along the way.

Happy New Year!

With warm regards,

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

Annualized Performance Summary (Net of Fees) As of 12/31/2022

CEA (Master): 1 Year: -16.9% | 3 Year: 2.2% | 5 Year: 6.0% | 10 Year: 12.0%

Russell 3000 TR: 1 Year: -19.2% | 3 Year: 7.1% | 5 Year: 8.8% | 10 Year: 12.1%

Corp. Bond: 1 Year: -7.1% | 3 Year: -0.6% | 5 Year: 1.1% | 10 Year: 2.3%

B of A ML 3-5 Year: 1 Year: -8.2% | 3 Year: -0.7% | 5 Year: 1.4% | 10 Year: 2.0%

Large Cap Yield: 1 Year: -8.2% | 3 Year: 6.7% | 5 Year: 6.7% | 10 Year: 9.1%

DJIA: 1 Year: -8.8% | 3 Year: 5.1% | 5 Year: 6.0% | 10 Year: 9.7%

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 96% 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. The Preferred Income product’s primary goal is to provide current income with secondary objectives of total return and tax efficiency. The Preferred Income product will primarily buy Preferred Equity but maintains the flexibility to hold other hybrid instruments such as Convertible or Baby Bonds. Holdings may be either investment grade or high yield. 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).