Sandler Associates Fund Returns 5% in 2011

January 20, 2012
Dear Partner,

We are pleased to provide this update on Sandler Associates (the “Fund”). Your individual capital account statement for year-end was delivered directly from the Fund’s administrator, Morgan Stanley Fund Services. Please let us know if you have not received it. Also, please be sure to review the end of this letter for several important announcements.

As shown below, the Fund was down approximately 0.7% net for the quarter, while the broad equity market indices posted double digit gains and the average long/short equity fund was up about 2%. The Fund finished the year up about 4.9% net. It was a disappointing quarter but capped a fairly successful year overall, especially relative to most equity indices and other long/short equity funds. Fourth quarter gains for equities were driven by a 20% intra month rally in October during which our short book performed poorly as the worst stocks rallied the most off the bottom. The rally was then followed by a choppy and challenging November and December.
1. Investment performance data is net of all fees, expenses, and incentive allocation and includes the reinvestment of all income, dividends and gains. Class A interests were charged a 1.0% management fee prior to April 2009 and after September 2011, and a 1.5% management fee in between. Class B interests were charged a 1.5% management fee since inception. Class A-U and B-U interests are eligible to participate in New Issues and Class A-R and B-R interests are ineligible. Unless otherwise indicated, Fund results reported in this letter are for Class A-U interests. Past performance is not necessarily indicative of future results. Fund results for 2011 are unaudited and subject to revision.
2. Market indices and benchmarks referred to in this letter are for illustration purposes only and have limitations when used for such purposes because they may have volatility or other material characteristics that are different from the Fund’s.

As shown below, during the fourth quarter, long positions added 5.0% to return while short positions detracted 5.3%, on a gross basis. On a standalone basis, the long portfolio was up 8.6% for the quarter while the short portfolio was down 14.8%, indicating significant negative alpha from stock selection during the period which was primarily driven by the run-up in the short portfolio during October.

Somewhat ironically, performance for the full year was driven by the short portfolio as we pressed our shorts at the right time, during the third quarter. For 2011, long positions added 0.2% to return and short positions added 8.5%, on a gross basis. On a standalone basis, the long portfolio was down 4.0% for the year while the short portfolio was up 3.6%, indicating flat stock picking results for the full year.

On a sector basis, positions in Industrials added most to performance during the fourth quarter (132 basis points), followed by positions in Tactical Market Indices (70 bps), Consumer Discretionary (57 bps), Consumer Staples (15 bps), and Utilities (5 bps). Positions in Materials detracted most from performance during the quarter (90 bps), followed by positions in Information Technology (77 bps), Energy (60 bps), Financials (40 bps), Healthcare (22 bps), and Telecommunications (13 bps). Currency hedging detracted from return for the quarter (14 bps).

For the year, the Fund exhibited a very favorable distribution of returns as the portfolio made money in every sector. Positions in Industrials added most to performance (229 basis points), followed by positions in Consumer Staples (165 bps), Energy (124 bps), Healthcare (93 bps), Materials (86 bps), Financials (61 bps), Tactical Market Indices (38 bps), Information Technology (32 bps), Utilities (29 bps), Telecommunication Services (18 bps), and Consumer Discretionary (17 bps). Currency hedging detracted from return for the year (45 bps). During the fourth quarter, the Fund’s delta-adjusted exposure averaged approximately 15% net long and 107% gross, while beta-adjusted exposure averaged approximately 21% net long and 119% gross. During 2011, the Fund’s delta-adjusted exposure averaged approximately 29% net long and 144% gross, while beta-adjusted exposure averaged approximately 35% net long and 158% gross.

As shown in the following chart, the Fund ended the year 18% net long on a delta-adjusted basis and 20% net long on a beta-adjusted basis. Gross exposure at year-end was 116% delta-adjusted and 135% beta-adjusted.

The following chart shows the Fund’s exposure by sector at year-end.

As shown above, our largest gross exposures by sector at year-end were 38% in Industrials, 28% in Consumer Discretionary, and 17% in Information Technology. The Fund ended the year with its largest net long exposures in Industrials (11%) and Consumer Discretionary (7%). The Fund had its largest net short exposure in Materials (4%) and had 3% or less net exposure in all other sectors.

The portfolio had positions in about 180 issuers at year-end and the largest single position was approximately 3.2% of assets.

Top Purchases/Sales
The three largest net purchases during the quarter, excluding ETFs, were of common stock in Rockwell Automation, Inc. (ROK), Spectris plc (London – SXS), and Clean Harbors, Inc. (CLH).

• Rockwell Automation is a global provider of industrial automation power, control and information solutions to manufacturing companies. We believe automation is being driven by several secular forces including the manufacturing of higher levels of goods in China, the need to combat higher labor costs in manufacturing-based emerging economies through increased productivity, consumer demand for higher quality products in the developing world, and low financing rates. We believe Rockwell is well positioned to capture this growth due to a superior product suite, favorable geographic exposures, and an increasing market share. In addition, we believe the company’s valuation is attractive vs. its peers and that it could be a strategic acquisition candidate for larger industrial conglomerates.

• Spectris develops and markets productivity-enhancing instrumentation and controls. This investment is also part of our testing and inspections theme as the company is involved in testing and calibration of complex equipment. We believe the company’s valuation is very attractive compared to its peers and that investors are underestimating the incremental margins the company can achieve as overall product complexity and levels of calibration and testing precision increase. The company should also benefit from exposure to strong end markets such as metals & mining, biotech, and aerospace while it has limited exposure to government and academic spend which could come under
austerity pressure. The company generates strong returns and free cash flow as its depreciation and amortization is in excess of its required maintenance cap-ex. We also believe Spectris is an attractive strategic acquisition target.

• We repurchased Clean Harbors, a provider of environmental, energy and industrial services, as the economy in the United States showed acceleration during the fourth quarter. The company continues to have strong pricing power in its incineration business and we believe its business in the Canadian Oil Sands is in the early innings of growth. In addition, we believe that the company’s balance sheet is well positioned for strategic acquisitions, something the company has done very effectively in the past.


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