Sound Shore Fund annual letter for the fourth quarter ended December 31, 2015.
The Sound Shore Fund’s Investor Class (ticker SSHFX) ended December 31, 2015 with a net asset value of $41.30 per share, after an income distribution of $0.391204 and a year-end capital gains distribution of $4.738991 per share. The fourth quarter total return of 5.33% lagged the Standard & Poor’s 500 Index (“S&P 500”) which rose 7.04% and the Dow Jones Industrial Average (“Dow Jones”) which rose 7.70%. For the year, the Fund’s Investor Class declined 5.02% which trailed the S&P 500 and the Dow Jones, which had returns of 1.38% and 0.21%, respectively.
We are required by the SEC to say that: Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. The Fund’s Investor Class 1, 5, 10, and 15-year average annual total returns for the period ended December 31, 2015 were -5.02%, 10.96%, 6.28%, and 6.31%, respectively. For the most recent month end performance, please visit the Fund’s website at www.soundshorefund.com. As stated in the current prospectus, dated May 1, 2015, the Fund’s Investor Class total annual operating expense ratio (gross) is 0.92%. Subsequently, for the fiscal year ended December 31, 2015, the total annual operating expense ratio (gross) was 0.93%, as shown in the financial highlights later in this annual report.
Sound Shore Management is proud to highlight that the Sound Shore Fund just received its 19th consecutive annual award as one of Money Magazine’s “Top Mutual Funds.” We thank all our investors, so many of whom are long-term, for placing their confidence with Sound Shore, proving once again that consistency and patience are critical to investment success. A $10,000 investment made at the Fund’s inception 30 years ago, with dividends reinvested, would have grown 23 fold to $236,870 through 12/31/15, as shown in the chart below.
For 2015, the S&P 500 Index finished marginally lower, though its return was slightly positive when including its dividends. The benchmark’s flat results mirrored similarly stalled corporate earnings per share that were held back by uneven global growth, currency volatility, and commodity price declines. Likewise, management commentary, especially in the second half, referenced offsetting trends of an industrial recession and disruptive winners, especially where technology and consumer priorities overlapped.
As often happens after a multi-year bull market, last year’s sideways move also included signs of narrowing stock leadership. For example, the equally weighted S&P 500 trailed the more conventionally referenced market capitalization weighted version by 359 basis points. Also, the Russell 1000 Growth (up 5.67%) benchmark outdistanced its Value counterpart (-3.83%) by 950 basis points, as the former was boosted by a handful of strong performing social media and biotech stocks.
Sound Shore Fund- Portfolio Review
Sound Shore’s 2015 results slightly trailed the value benchmark in spite of a number of solid 2015 contributors including General Electric, which advanced as it exited from its finance segment, and lab supplier Thermo Fisher Scientific which benefited from market share gains and recent acquisition synergies. These contributors were offset by declines at packaging leader International Paper, which faced currency headwinds, and integrated oil BP, our only energy holding for the bulk of the year, which declined with commodity prices. Importantly, IP, BP, and a few other holdings impacted by global economic weakness have strong balance sheets and full cycle staying power, critical advantages given current credit market conditions.
Meanwhile within technology, Microsoft, another strong performer, was offset by Oracle, among the year’s larger detractors, illustrating the market’s intensified focus on industry market share battles. We restarted our Microsoft holding in the third quarter when its valuation, net of $60 billion in cash, had declined to 13 times forward earnings with an 8% free cash flow yield. At the time, investors were worried that the completion of its cost cutting plan would slow earnings growth. Our research, however, determined that Microsoft’s best in class cloud platform products, especially Office 365, were gaining momentum and driving near term earnings growth. In fact, cross checks suggested that technology archrival Apple was even using Microsoft’s cloud offerings, confirming their merit. Since our purchase, Microsoft has advanced 30.8% as its enterprise success drove above-consensus earnings and signaled the company was among the disruptive technology winners.
By contrast, Oracle returned to levels where we initiated our position, declining 18% in 2015, due to uncertainty over its progress on a similar path. We invested in Oracle in late 2014 when it was valued well below norm at 11 times earnings and investors were skeptical of the company’s growth prospects. We continue to view Oracle’s installed corporate customer base as a competitive edge, and we have collected favorable customer feedback on Oracle’s emerging cloud offerings which are growing rapidly and scheduled to reach critical mass during 2016. While we understand that markets typically wait for clear evidence of success, given our long term investment time horizon we used the stock’s underperformance to add to our position.
Microsoft and Oracle reflect more broadly on the dynamic between incumbents and challengers currently facing many industries. Though innovation and competition are certainly not new, the current pace and breadth of change are garnering attention. Sound Shore’s investment process includes driverspecific financial models by holding ongoing dialogues with management and primary sources in order to form an objective view of risks and opportunities. This due diligence incorporates an unbiased mindset regarding industry change and sector winners. But valuation continues to be a critical component of our investment process.
Sound Shore’s portfolio had a forward price-earnings multiple of 14 times at 12/31/15, a meaningful discount to the S&P 500 at 16 times. The pundits’ outlook for 2016 includes the usual list of positives election year, mergers and acquisitions, low energy prices) and negatives (peak profit margins, problematic high yield markets, sovereign risk). We believe Sound Shore’s contrarian investment process, which focuses on valuing out of favor stocks and identifying company-specific sources of revenue, earnings and cash flow growth, should continue to surface profitable investment opportunities.
Best wishes for 2016 from everyone at Sound Shore Management.
Thank you for your investment alongside ours in Sound Shore.
SOUND SHORE FUND
Harry Burn, III
John P. DeGulis
T. Gibbs Kane, Jr.