Cutting Buffett Helps Sequoia Fund Top Value Investor Rankings - Bloomberg

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Cutting Buffett Helps Sequoia Fund Top Value Investor Rankings

By Charles Stein - Dec 29, 2011

Sequoia Fund Inc., (SEQUX) recommended by Warren Buffett when it opened, beat the U.S. stock market over the past four decades, in part because a large piece of the fund was invested in his company, Berkshire Hathaway Inc. (BRK/A) Heeding Buffetts warning that Berkshire wouldnt grow as fast as it once did, the managers of the $4.7 billion fund cut their reliance on the stock almost in half in 2010 and put the cash into companies such as Valeant Pharmaceuticals International Inc. (VRX), a drug distributor. Sequoia is beating the pack again this year, gaining 14 percent through Dec. 27, better than 99 percent of value stock funds, according to data compiled by Bloomberg. They have the kind of portfolio Buffett might have if he ran a mutual fund, Steven Roge, a portfolio manager with Bohemia, New York-based R.W. Roge & Co., said in a telephone interview. His firm, which oversees $200 million, holds shares in Sequoia. Like Buffett, the managers of Sequoia look for high-quality companies with competitive advantages that the fund can hang onto for long periods. While the scale of Buffetts $68 billion stock portfolio forces him to buy mainly the largest companies, Sequoia is small enough to benefit from investments in mid-sized businesses. The fund beat 97 percent of peers over the past 10 and 15 years, according to Morningstar Inc. (MORN) in Chicago. From 1970 to 2010 the fund returned 14 percent annually, compared with 11 percent for the Standard & Poors 500 Index. In its best year, 1976, the fund gained 72 percent, according to The Warren Buffett Way (John Wiley & Sons, 1994) by Robert Hagstrom. It lost 27 percent in its worst year, 2008.

Buffetts Praise
Sequoia Fund was co-founded in 1970 by Richard Cunniff and William Ruane, a friend of Buffett since both studied under legendary value investor Benjamin Graham at Columbia University in

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Cutting Buffett Helps Sequoia Fund Top Value Investor Rankings - Bloomberg

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1951. When Buffett shut down his investment partnership in 1969 to concentrate on Berkshire Hathaway, he recommended that his clients invest with Ruane. Bill formed Sequoia Fund to take care of the smaller investor, Buffett wrote in an e-mailed response to questions. A significant percentage of my former partners went with him and many of those still living have their holdings of Sequoia. Ruane ran an unconventional fund, closing Sequoia to new investors in 1982 because he didnt want its size to limit what the fund could buy. It opened again in 2008, three years after Ruanes death. Ruane also held a concentrated portfolio. In 2003, Sequoia had 75 percent of its money in its top six holdings, according to a regulatory filing.

Six Best Ideas

Ruane believed that your six best ideas in life are going to do the best, David Poppe, who now runs the fund together with Robert Goldfarb, said at a May 2011 investor day for Ruane, Cunniff & Goldfarb Inc., the New York firm that advises Sequoia. Poppe and Goldfarb didnt respond to a request to be interviewed. The two were named domestic stock managers of the year for 2010 by Morningstar. They are finalists for the same award for 2011. Since Ruanes death, the firm has hired more analysts and added more holdings to the portfolio. At the end of 2010, Sequoia held 34 stocks, an all-time high, according to a letter to shareholders in the funds 2010 annual report. The same letter explained why Sequoia reduced its stake in Berkshire Hathaway.

Cutting Berkshire
When Warren Buffett tells the public that Berkshires growth rate will slow in the future, it behooves one to listen, the funds managers wrote. Buffett has said on a number of occasions that a company of Berkshires size cant grow at the pace it did when it was smaller. We know we cant do remotely as well in the future as we have in the past, Buffett said on April 30 at Berkshires annual meeting in Omaha. Berkshire represented 11 percent of Sequoias holdings as of Sept. 30, down from 20 percent at the end of 2009 and 35 percent in 2004, according to fund reports.

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Sequoias Berkshire stake has been a drag on the funds returns in recent years, said Kevin McDevitt, an analyst for Morningstar. Over the past five years, Sequoia rose 4.3 percent a year compared with an annual gain of 1 percent for Berkshire. Over 20 years through November, Berkshire outperformed Sequoia by 2.6 percentage points a year. There was a time when you could have said they were riding Buffetts coattails, McDevitt said in a telephone interview. Thats not the case anymore.

Long-Term Investor
A reduced Berkshire stake hasnt stopped the fund from investing in a style similar to Buffetts. In 2011, Buffett bought shares of MasterCard Inc. (MA) and International Business Machines Corp. (IBM), two companies Sequoia already owned. Buffetts portfolio contains stocks, such as Coca-Cola Co. (KO) and Wells Fargo & Co. (WFC), that he has owned for more than 20 years. Sequoia has holdings, including TJX Cos. (TJX) and Fastenal Co. (FAST), that have been in the fund for at least 10 years, regulatory filings show. TJX, a Framingham, Massachusetts-based discount retailer, has appreciated at a rate of 14 percent a year in the 10 years ended Nov. 30, compared with 2.9 percent for the Standard & Poors 500 Index, according to data compiled by Bloomberg. Fastenal, an industrial supplier based in Winona, Minnesota, gained 20 percent a year. As an investor, if you get the people and the business right, you can let a company do the hard work for you for a long time, Thomas Russo, a partner at Lancaster, Pennsylvania-based Gardner Russo & Gardner, said in a telephone interview. Russo, who worked at Ruanes firm from 1984 to 1989, manages $4 billion.

Good and Bad

Sequoias patience hasnt always paid off. Mohawk Industries Inc. (MHK), a carpet maker based in Calhoun, Georgia, and a longtime Sequoia holding, lost 19 percent of its value in the past five years as the housing slump depressed carpet sales. In the short term, holding Mohawk has been a really poor decision, Poppe said at the 2009 investor meeting. Such self-criticism is common at the meetings. At one session, an investment in Porsche Automobil Holding SE (PAH3), the German automaker, was described as a disaster. At another, a manager admitted the firm was too timid about buying MasterCard after it went public in 2006.

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They give you the good and the bad, said Roge, who has attended several of the firms investor meetings. Sequoias managers dont buy many of the largest stocks because the companies are too wellknown and too heavily followed on Wall Street. Their preference is to own businesses where we believe, not always correctly, that we have an edge in information, they wrote in their 2009 letter to shareholders.

Valeant Stake
Valeant Pharmaceuticals, the funds largest holding, had a market value of less than $7.5 billion (VRX) when Sequoia purchased it in the third quarter of 2010, Bloomberg data show. The Mississauga, Ontario, drug company gained 62 percent this year. At the 2011 investor meeting, the funds managers emphasized Valeants unusual business model, which focuses on acquiring drugs with a proven track record rather than spending money on research and development. They also praised the firms chief executive officer, J. Michael Pearson. Goldfarb told investors that over time he has become convinced that the right executive is crucial to a businesss success. Were betting more on the jockey and a little less on the horse, he said in May at the funds annual meeting. Sequoia typically has far more cash than the 3.7 percent held by the average U.S. domestic stock fund. At the end of the third quarter, cash represented 27 percent of the funds assets, according to data compiled by Bloomberg.

Holding Cash
Other well-known value investors, such as Seth Klarman, founder of Baupost Group LLC, a Boston -based hedge fund, and Robert Rodriguez, the longtime manager of FPA Capital Fund and current CEO of Los Angeles-based First Pacific Advisors, let cash build up when they cant find enough attractive investments. In good markets cash can be a drag, but we have not had many good markets lately, Dan Teed, president of Wedgewood Investors Inc. in Erie, Pennsylvania, said in a telephone interview. Teed, whose firm manages more than $100 million, including shares of Sequoia, said the funds cash was a plus because it means they arent afraid to take a defensive position.

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Debt Dangers
Klarman and Rodriguez have written about the dangers of the increase in U.S. government debt, warning that it could pose a threat to the economy and the stock market if it is not whittled down. Goldfarb normally ducks questions about macroeconomic issues at annual meetings, saying he has no special insight into the future of the economy, interest rates or the prices of oil and gold. At the 2011 annual meeting, in response to an investor question, he sounded a gloomy note about deficits. My own feeling is that were just repeating the housing bubble in a different form, he said. Weve substituted an unsustainable buildup of government debt for what is an unsustainable buildup of consumer debt. This one really feels worse to me and more dangerous. I think were living in a time of false prosperity. To contact the reporter on this story: Charles Stein in Boston at cstein4@bloomberg.net To contact the editor responsible for this story: Christian Baumgaertel in Boston at cbaumgaertel@bloomberg.net
2011 BLOOMBERG L.P. ALL RIGHTS RESERVED.

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