Value Added


A Sturdy Fund for Uncertain Times

Steven Goldberg

Sequoia Fund won't keep you up at night because its managers work so hard at reducing risks.



Relatively speaking, Sequoia Fund (symbol SEQUX) is having a subpar year. Through November 5, the fund gained 13.1%, trailing Standard & Poor's 500-stock index by 1.6 percentage points. If that bothers you, you probably should stay away.

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Sequoia's managers worry a lot more about reducing risk than about topping annual performance charts. In years when the stock market is strong -- such as 2003, 2004, 2006, 2009 and 2012 -- Sequoia lags.

Where the fund has shone -- relative to its peers -- is in flat and bad markets. During the 2007-09 bear market, Sequoia lost 44.3%, but the S&P 500 plunged 55.3%. In the 2000-02 bear market, the S&P tumbled 47.4%, but Sequoia gained 21.5%.

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Add up the yearly returns and you find superb long-term results. Over the past 15 years, Sequoia returned an annualized 7.9%. That's an average of 3.3 percentage points per year better than the S&P.

Sequoia has done so well in a treacherous era for stocks partly because it usually holds cash. The fund, which at last word had 18% of its assets in the green stuff, has been 27% less volatile than the S&P over the past three years.

But the major reason this fund has been so good, I think, is the great care the managers and analysts take in buying and selling stocks. Co-managers Bob Goldfarb and David Poppe seek companies that boast high profit margins and low debt and that dominate their markets. They hunt for first-rate executives. They invest in these high-quality, well-managed businesses only when their stocks sell at a big discount to Sequoia's estimate of the underlying company's fair value.

Once they invest, they hold on. Stocks stay in the fund for an average of ten years. Poppe likens selling a stock to getting a divorce. "It is wrenching to have to sell," he says. (The managers rarely give media interviews; the comments in this article were made at the fund's annual investor day.)

Sequoia has long had close ties to Warren Buffett, and in years past, Buffett's Berkshire Hathaway (BRK.B) accounted for as much as half of the fund's assets. Critics questioned why anyone would pay Sequoia its annual fees when the fund was stuffed to the gills with Berkshire. Warren Buffett's company is still about 10% of the fund's assets. But over the past 15 years, Sequoia has outperformed Berkshire.

Sequoia isn't tiny, but with assets of $5.7 billion, it is manageable. That's important because the fund often takes big positions, sometimes in midsize companies. For instance, the fund at last word had 9.3% of its assets in Valeant Pharmaceuticals International (VRX). That's not an insignificant stake for a company with a market value of $16.8 billion.

Sequoia currently owns 46 stocks. That's an increase over past years, when the fund was even more concentrated. The number of stocks has risen as Sequoia's analyst count has grown to more than a dozen.

As Sequoia's managers and analysts tell it -- in their yearly public meeting -- each stock has its own story, often one that involves confidence in executives as much as confidence in a business. Valeant, for instance, has been a serial acquirer of other drug companies. Valeant's managers increase the profit margins at their acquisitions by implementing efficiencies. That means Valeant is only as good as its executives' ability to identify attractive takeover candidates.

Sequoia doesn't try to predict what will happen in Europe or China -- or in the U.S. economy. "We generally do not look for big trends," Goldfarb says. "It is one stock at a time."

They own Advance Auto Parts (AAP) and O'Reilly Automotive (ORLY) because they like the auto-parts business. When shoppers or repair shops need parts, they usually need them in a hurry. Price is secondary. That means the business faces little threat from the Internet.

Sequoia's managers and analysts do painstaking work before investing in any stock. Analyst John Harris may have put it best: "We don't assume that things are going to go swimmingly. We don't think about what happens to this investment if there is a recession. We think about what happens when there is a recession. The recession that we think about is probably a little deeper and darker than the ones most people think about when they make their decisions." This may explain why bear-market returns have been so good.

Sequoia does no marketing. In fact, for 26 years until 2008, it was closed to new investors. Last January, it closed to investors using intermediaries, such as discount brokerages. If you want Sequoia, you have to buy it through the fund. Visit SequoiaFund.com to learn how.


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Steven T. Goldberg is an investment adviser in the Washington, D.C. area.



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