Newsletter
October 26, 2010
Dear client and prospective client,
As we move through the middle of October, I continue to think that we are having a strong rally in a secular bear market. Of the structural problems that have existed in the United States over the past few years, none have gone away. A staggering deficit (just closed the books on a $1.3 trillion dollar fiscal 2010 deficit), mindlessly low interest rates (someday Bernake will understand that people will borrow recklessly when it doesn't cost anything), stubbornly high unemployment, a faltering currency (loss of purchasing power), and a continued loss of our country's manufacturing base are all structural and problematic.
The premise for the rally was a good one...the Republicans would gain control of the House and/or the Senate and stop the excessive spending of the federal government. The odds look good for the Republicans, but the reason the rally may falter is that Republican control of the House and/or the Senate will only achieve gridlock. Structural change has yet to be identified and executed.
Government officials and pundits have been puzzled by the high unemployment rate in the United States. With low interest rates, massive federal stimulus, and a turn in the economic cycle, how could unemployment remain between 9% and 10%? (We all know the real number is higher).
The simplest yet most elegant explanation to the unemployment question is that no one bothered to ask the business leaders of this country what was needed to accelerate job creation. Hiring decisions in this country are made by CEOs and business owners. When deficits run rampant, taxes are increasing, the Federal Reserve decides to follow rock bottom interest rates with massive quantitative easing (pumping money into our economic system), the CEOs and business owners know these structural problems may cause a very hard landing (or continued malaise) and are cautious about hiring. They also do not buy the fool's gold that public sector GDP can effectively replace private sector GDP.
Solutions
The solution to our country's economic malaise is to first balance the budget. I have said it for years. Addressing trade deficits (the exportation of our country's wealth) would also help. After balancing the budget, tax cuts to stimulate capital and business formation is a logical second act.
For those who do not think that this is serious - consider this. The U.S. national debt now stands or over $10 trillion dollars or about 100% of our GDP. What business would survive or operate well with debt equal to revenue? So...while we have borrowed over $10 trillion from home and abroad, the Chinese have saved $2 trillion in U.S. currency in their central bank. The Chinese also own a substantial portion of our national debt.
When we think of solutions, we better think quickly because we are getting into a place from which it is difficult to recover. As we speak, the U.S. dollar is slowly losing its status as the world's reserve currency. If that happens, no one will be interested in funding our national deficit.
Performance
We continue to post solid performance and deliver for our clients. Our year to date return through September 30, 2010 and our longer term returns are below.
The most important measure of the job we are doing, our long term performance, remains strong. We have beaten our benchmarks since inception.
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* Concentrated Equity Alpha Composite presented gross of management fees. Since inception returns is presented cumulative. |
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Past performance is not a guarantee of future performance. Individual investor results will vary. Performance results may be materially affected by market conditions and economic conditions. Full performance disclosures are provided at the end of this letter. The disclosures provided are considered an integral part of this presentation.
GIPS® compliance
Sandhill claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is widely recognized as the gold standard for accuracy and integrity in reporting performance results. Sandhill has been verified as GIPS® compliant for the periods from March 31, 2004 through December 31, 2009 by Mengel, Metzger Barr & Co., LLP.
Asset Growth at Sandhill
The value of a $10,000 investment in Sandhill's core equity product since inception relative to the indices can be found below:
Institutional markets
As Sandhill has almost tripled in size in the last three years, it is time to begin to sell to institutional markets. Our performance results stand up nationally and we have reached a critical mass where we have the resources to begin the process. It is our belief that entry into the institutional markets will only make us better. Competing against the best keeps you sharp.
Sandhill defines institutional markets as investment consultants, pension plans, Taft Hartley plans, fund of funds, large brokerage houses, and family offices.
Going to market
As we begin to pursue larger and more sophisticated clients, I often get asked, "What makes Sandhill unique?"
There are three answers:
- Sandhill manages concentrated portfolios. Our average portfolio holds about twenty five stocks. We want our clients to be exposed to our research and ideas.
- Sandhill buys stocks of all market capitalizations - large, mid, and small cap companies. We see no need to limit our purchases by market capitalization. We want the best companies in our portfolios...regardless of size.
- Sandhill makes very few investment mistakes. We don't get it all right...no one does, but one of our attributes is that over the life of the firm, we have had very few "problem" stocks.
There are two reasons that we have limited our mistakes. First, we buy stocks that have strong free cash flows, strong balance sheets, high return on invested capital, are healthy businesses, and have stable, highly recurring revenue. Second, we are very good at valuing securities and do not overpay for our portfolio companies..
Thematic investing
As Sandhill matures, I would say that one area in which we have gotten better is thematic investing. By that, I mean that the research team has gotten good at identifying trends early and then figuring out how to exploit them in the equity markets.
Current themes that we have invested in and are benefitting from are global food demand and the boom in agriculture, the weakening dollar and sharp rise in commodity prices, and the aerospace cycle.
We currently have a multi sector/industry bet on rising interest rates. This will take time to play out.
Rick Ryskalczyk
As Sandhill generates more cash, I continue to allocate capital to the investment team.
Sandhill recently hired Rick Ryskalczyk. Rick graduated from Canisius College in May 2010 with a 3.9 GPA. Rick graduated summa cum laude and on the Dean's list. Rick received the Nelson D. Civello Most Outstanding Graduate Award - the top honor for Canisius's economics and finance department.
Hope everyone is well.
Warm regards,
Edwin M. "Tim" Johnston III
Managing Partner
Performance Disclosures:
Sandhill Investment Management ("Sandhill") is a registered investment advisor that is not affiliated with any parent company. The performance statistics disclosed above are calculated on the rates of return from accounts managed by Sandhill, as defined below. These accounts are managed by Sandhill on a discretionary basis and have no restriction in the manner in which the account can be invested. There are no non-fee paying accounts included in the Concentrated Equity Alpha Composite. The U.S. dollar is the currency used to express performance. The Concentrated Equity Alpha Composite includes 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 Concentrated Equity Alpha Composite through the completion of the last full month under management and are not removed from the historical rates of return. There is no minimum asset size requirement for inclusion in the Concentrated Equity Alpha Composite. The returns are shown gross of investment management fees. The Concentrated Equity Alpha Composite was created on March 1, 2004.
Sandhill claims compliance with the Global Investment Performance Standards (GIPS®).
To request a complete list and description of firm composites and/or a full performance presentation that adheres to GIPS® Standards, please contact Kelly Marshall at (716) 852-0279 x. 307 or kmarshall@sandhill-im.com.