Buffett Lite fund vaults to top by lightening up on Buffett

JAN 01, 2012
By  John Goff
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) But in 2010, the managers of the $4.7 billion fund heeded Mr. Buffett's warning that Berkshire wouldn't grow as fast as it once did, and cut their reliance on the stock almost in half, putting the cash instead in companies such as drug distributor Valeant Pharmaceuticals International Inc. (VRX). Sequoia beat the pack again last year, gaining 14% through Dec. 27, better than 99% of all value stock funds, according to data compiled by Bloomberg. “They have the kind of portfolio Buffett might have if he ran a mutual fund,” said Steven Roge, a portfolio manager with R.W. Roge & Co. His firm, which oversees $200 million, holds shares in Sequoia. Like Mr. Buffett, the managers of Sequoia look for high-quality companies with competitive advantages that the fund can hang on to for long periods. While the scale of Mr. Buffett's $68 billion stock portfolio forces him to buy mainly the largest companies, Sequoia is small enough to benefit from investments in midsize businesses. The fund beat 97% of its peers over the past 10- and 15-year periods, according to Morningstar Inc. From 1970 to 2010, the fund returned 14% annually, compared with 11% for the S&P 500. In its best year, 1976, the fund gained 72%, according to “The Warren Buffett Way” by Robert Hagstrom (John Wiley & Sons, 1994). It lost 27% in its worst year, 2008. Sequoia Fund was co-founded in 1970 by Richard Cunniff and William Ruane, a friend of Mr. Buffett's since both studied under legendary value investor Benjamin Graham at Columbia University in 1951. When Mr. Buffett shut down his investment partnership in 1969 to concentrate on Berkshire Hathaway, he recommended that his clients invest with Mr. Ruane. “Bill formed Sequoia Fund to take care of the smaller investor,” Mr. Buffett wrote in an e-mail. “A significant percentage of my former partners went with him, and many of those still living have their holdings of Sequoia.” Mr. Ruane ran an unconventional fund, closing Sequoia to new investors in 1982 because he didn't want its size to limit what the fund could buy. It opened again in 2008, three years after Mr. Ruane's death. The fund also held a concentrated portfolio. In 2003, Sequoia had 75% of its money in its top six holdings, according to a regulatory filing. Mr. 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 last May at an investor day for Ruane Cunniff & Goldfarb Inc., the firm that advises Sequoia. Mr. Poppe and Mr. Goldfarb didn't 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 Mr. Ruane's 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 fund's 2010 annual report. The same letter explained why Sequoia reduced its stake in Berkshire Hathaway. “When Warren Buffett tells the public that Berkshire's growth rate will slow in the future, it behooves one to listen,” the fund's managers wrote. Mr. Buffett has said on a number of occasions that a company of Berkshire's size can't grow at the pace it did when it was smaller. Berkshire represented 11% of Sequoia's holdings as of Sept. 30, down from 20% at the end of 2009 and 35% in 2004, according to fund reports. Sequoia's Berkshire stake has been a drag on the fund's returns in recent years, said Morningstar analyst Kevin McDevitt. Over the past five-year period, Sequoia rose 4.3% a year, compared with an annual gain of 1% for Berkshire. Over the 20-year period through November, Berkshire outperformed Sequoia by 2.6 percentage points a year. “There was a time when you could have said they were riding Buffett's coattails,” Mr. McDevitt said. “That's not the case anymore.” A reduced Berkshire stake hasn't stopped the fund from investing in a style similar to Mr. Buffett's. In 2011, Mr. Buffett bought shares of MasterCard Inc. (MA) and International Business Machines Corp. (IBM), two companies Sequoia already owned. Mr. Buffett's 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 discount retailer, appreciated at a rate of 14% a year over the 10-year period ended Nov. 30, compared with 2.9% for the S&P 500, according to data compiled by Bloomberg. Fastenal, an industrial supplier, gained 20% 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,” said Thomas Russo, a partner at Gardner Russo & Gardner, who once worked at Mr. Ruane's firm. His firm manages $4 billion. Sequoia's patience hasn't always paid off. Carpet maker Mohawk Industries Inc. (MHK), a longtime Sequoia holding, lost 19% of its value over the past five-year period as the housing slump depressed carpet sales. Sequoia's managers don't buy many of the largest stocks, because the companies are too well-known 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.

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