Sequoia fund gives departing shareholders stock instead of cash

In-kind redemptions rare but legal

Apr 14, 2016 @ 1:56 pm

By John Waggoner

The snakebit Sequoia fund is warning investors that large redemptions may be paid in securities, rather than cash.

Sequoia (SEQUX), which has tumbled 24% the past 12 months on a big, bad bet on drugmaker Valeant Pharmaceuticals (VRX), notified investors on its web page about its policy. The notice says, in part:

“The Fund has adopted a policy under which the Fund may limit cash payments in connection with redemption requests to $250,000 during any ninety (90) day period. As a result, the Fund may pay you in securities or partly in securities if the amount of Fund shares that you redeem is more than $250,000.

It is highly likely that the Fund will pay you in securities or partly in securities if you make a redemption (or series of redemptions) in the amount of $250,000 or greater.”

A provision in the 1940 Investment Company Act allows funds to pay redemptions in securities, rather than cash, but it's a provision that's rarely used, in part because in-kind redemptions could damage a fund's reputation. (Fund companies are also allowed to waive the right to in-kind redemptions to a certain extent).

Under the law, the fund doesn't have to distribute in-kind redemptions in proportion to the fund's holdings. According to the Wall Street Journal, one recent investor received 5% of his redemption in cash, with the remaining in shares of O'Reilly Automotive (ORLY).

Someone who gets just one stock for a distribution clearly doesn't get any benefit from diversification. And transferring shares from the fund to the shareholder can be a complex operation. The advantage to the fund: The investor, not the fund, would bear the cost of liquidating the security.

The tax basis for the fund would be its purchase price, and its sale price that day would determine your gain or loss. If you received shares of a stock from the fund and those shares fell before you sold it, you'd have a capital loss.

Sequoia, long a highly ranked value fund, took a large stake in Valeant that eventually reached 30% of the fund's portfolio. The stock has plunged 84% the past 12 months, and Robert Goldfarb, one of the fund's long-time managers, resigned last month. The fund's 15-year record still tops the Standard & Poor's 500 stock index and 97% of funds in its Morningstar category.

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