Newsletter
December 27, 2011
Dear clients and friends,
I wanted to pen a quick note before the end of the year. I am not sure exactly where our performance will finish in 2011, but as a firm it will be roughly in line with the broad indices.
Sandhill had spectacular performance relative to the markets in 2009 and 2010. The stock market has been a wash in 2011 – with regard to both the market's performance and our performance relative to the market. We did a very mediocre job this year that was below our long term standard.
There will inevitably be periods of boredom (no return) over the course of maintaining a securities portfolio, and many investors get frustrated by those “quiet” times. In 2011, there was not only no return, but a lot of volatility which many find discomforting.
Volatility does not bother us…..in fact a good money manager will take advantage of volatility. While volatility is a component of risk, we still think the quality of the assets and the cash flows that these assets produce is the truest measure of risk.
We did take a fair amount of time in the second half of 2011 to take some of the volatility out of our portfolios. I give Matt Wiens – Sandhill's co-founder – great credit for this. We added Snyders Lance (LNCE) to our portfolios and are off to a good start with our position. The next time you are eating Snyders Pretzels or Cape Cod potato chips know that you are an owner of the company. Matt also saw a firming of pricing in the property and casualty insurance market and we bought W.R. Berkley (WRB). Bill Berkley is one of the smartest operators in the business and very disciplined with regard to pricing risk. We are also off to a good start with our position in WRB.
Both Snyders and W.R. Berkley are stable, recurring revenue businesses with very diversified revenue streams. We believe these businesses can grow. Both pay a dividend.
Looking ahead
I remain adamant that the equity markets will make no real progress until our federal deficit problem is solved. The U.S. economy is acting well and corporate America is in great shape, but you can not run an economy with a currency that is not sound. The ignorance and arrogance of Washington is truly breathtaking. I would think with $4 trillion to play with each year, they could balance the check book. Such concepts as issuing debt (treasury bonds) and then having the Fed print money and buy that debt in the open market to lower interest rates is really mind boggling.
If these massive annual deficits are ever dealt with, it would be incredibly bullish for the U.S. equity markets. But time is running out. We will reach a tipping point, and I think it is closer than we think.
So if there is one issue that you should follow next year, it is whether our federal government is making any structural changes that will reduce or eliminate the deficit.
The damage
If one thinks our excessive spending has not caused any damage, think otherwise. First, the stock market is unchanged over the last decade. The real damage comes when you consider that the market is really down approximately 50% when measured against a basket of global currencies.
So…..our stock market is stalled and the dollar is devaluing by the day as we print money to pay our bills. The U.S. is still the leading reserve currency in the world, but that is changing quickly.
To give you an example, today China and Japan signed an agreement where trade between the countries can be settled directly with yen/yuan (the Chinese currency) exchange. The interim step of converting to U.S. dollars will be eliminated. The agreement is still embryonic, but this is yet another indicator of the diminishing importance of the U.S. dollar.
When you think of your financial assets, don't just think of the assets you own but the value of the currency in which the assets are denominated.
Inflation
I have come to think that there are two kinds inflation and we are being sold a bag of goods in how inflation is communicated to the American people.
The first kind of inflation is real inflation. Demand driven inflation. Demand is so strong that you have to pay more to purchase what you want. This is healthy inflation. We have very little real inflation in the United States.
The second kind of inflation is caused by the declining dollar. Gold has soared in value not because demand for gold has gone off the charts. Rather, gold is denominated in U.S. dollars and it takes more (devalued) dollars to buy an ounce of gold. Another example is that it takes more (devalued) dollars to pay for foreign labor that produces goods that are exported to the United States.
So…..bringing this all together – the stock market has remained flat, the value of the U.S. dollar has declined, life has gotten way more expensive because it takes more devalued dollars to buy goods and services…..not a healthy cycle. This phenomenon is one of the drivers that is causing civil unrest in the United States.
New products
Sandhill has two products that have been utilized by our customers to combat inflation and deal with low interest rates.
First, our hard asset portfolio is a portfolio of 35 stocks of producers of everything that comes out of the earth – gold, silver, coal, gas oil, potassium, etc. As the dollar declines, the value of these commodities in dollar terms have gone up. This portfolio is a great inflation hedge and a good way to retain purchasing power. Minimum account size is $500,000.
Second, our short term corporate bond portfolio has been very effective as well. This portfolio is a great way to produce income. Maximum maturity is eight years. Portfolios are highly diversified to minimize credit risk. Bonds are single B to single A in rating. The average yield to maturity of the bonds we purchase is roughly 5.5%. This compares to an eight year Treasury bond with a yield to maturity of approximately 1.5%.
Adding value
It is important that we go through the thought processes (above) to frame our investment strategy. However, I still think the game is won or lost on the individual security level……that is, our ability to pick stocks, to own great operating businesses.
Sandhill's official performance started March 1, 2004. Since inception to November 30, 2011, our equity investments have increased 54.0% (gross of fees) vs. an increase of 27.5% for the S&P 500 Total Return Index and 31.7% for the Russell 3000 Total Return Index.
My best to everyone for a happy and healthy 2012.
Warm regards,
Edwin M. “Tim” Johnston III
Co-founder and Managing Partner
This report has been prepared for informational purposes only and is neither a solicitation to buy or sell securities. The information in this report has been obtained from sources believed to be accurate; however, Sandhill Investment Management makes no guarantee as to the accuracy or completeness of the information.
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.