Goldberg's Picks for Low-Risk Stock Funds: Sequoia Is as Sturdy as Its Name
Note: Most investors couldn't care less about beating the market. They want solid returns from funds that will hold up well in awful markets. This is the first of five columns on my favorite low-risk stock funds.
When the storied Sequoia Fund (symbol SEQUX) reopened to new investors in 2008 for the first time since 1982, a lot of people, myself included, expected investors to inundate the fund with a torrent of new cash. After all, Sequoia was the fund that Warren Buffett recommended to his clients when he dissolved his investment partnership at the end of 1969 so that he could focus on running Berkshire Hathaway. And for years, Sequoia delivered Buffett-like returns.
But surprisingly few people invested. Indeed, the fund’s assets today total a relatively modest $4.4 billion -- not a lot, even for a fund that has 75% of its stock money in ten companies. Part of the reason for its relatively small size: Sequoia’s managers avoid the media. Co-manager David Poppe made a rare public appearance at the Morningstar fund conference last June, but he almost never grants interviews.
The fund’s investment strategy, however, is no secret. According to Sequoia’s latest annual report, Poppe and his co-manager, Robert Goldfarb, seek companies that dominate their markets, boast high profit margins and “extremely strong” balance sheets, fund their growth from earnings (rather than by borrowing money or selling new shares to the public), and are run by first-rate management teams. They buy these high-quality companies only when they’re trading at cheap prices relative to their “intrinsic value,” or the managers’ estimate of what a company is truly worth.
I know, I know. How many times have you heard that litany of criteria? The difference between Sequoia and the vast majority of similar stock funds is how well its managers execute their strategy.
The numbers speak volumes. From Sequoia’s inception on July 15, 1970, through August 30, it returned an annualized 14.2%, compared with 10.5% for Standard & Poor’s 500-stock index. Nor has the fund shown any signs of losing its mojo more recently. Over the past ten years, it returned an annualized 5.7%, an average of 3.0 percentage points per year better than the S&P 500.
Yet Sequoia has been 13% less volatile than the S&P over the past ten years. That’s partly because the fund tends to hold high cash positions (at last report, it had 21% of its assets in cash). Big cash holdings are also a key reason why the fund historically has held up better than most in inhospitable markets. The fund lost 44.3% in the 2007-09 bear market, compared with a 55.3% loss for the S&P 500. In the 2000-02 bear market, during which the S&P lost 47.4%, Sequoia gained 21.5%.
Founding co-manager William Ruane died in 2005, and Richard Cunniff, the other founding co-manager, stepped back from day-to-day operations in 1998.
But the firm is rich in talent they trained. Goldfarb became manager in 1998, and Poppe joined him as co-manager in 2005. They are supported by about a dozen analysts.
Although the managers focus on picking stocks, they don’t ignore the big picture. During the 2010 shareholders meeting, Goldfarb worried about the dollar and federal debt. “Getting people to volunteer to pay their share or take the pain in order to get our fiscal house in order is an enormous challenge,” he said. “I don’t think we’re there yet.” Talk about an understatement.
The managers and analysts display a deep knowledge of the relative handful of stocks they buy. At the 2010 meeting, they were asked why they had invested in Becton, Dickinson (BDX). The company, which the fund still owns, is the world’s largest manufacturer of medical needles and syringes, and also makes a variety of other medical tools and diagnostic equipment. Analyst Vish Arya explained: “The company’s cost structure is such that it’s very difficult for competitors to sell a comparable product for less. In fact, they can’t, really.” Increasing demand from emerging markets and the creation of new, safer and more sophisticated products are powering growth. Yet the stock, at $80.73, trades at just 13 times analysts’ expected per-share earnings for the coming 12 months (prices and related data are as of August 30).
Like Buffett, the managers aren’t afraid to admit mistakes. Of Martin Marietta Materials (MLM), which produces stone, sand and gravel used in construction, Goldfarb said last year, “We definitely bought it too high, and we may have sold it too low.” Sequoia bought the stock before the 2008 financial crisis, which triggered a collapse in construction.
One thing has changed at Sequoia: After nearly 20 years as its largest holding, Berkshire Hathaway (BRK.B) has slipped to number two, although it still accounts for a hefty 9.3% of the fund’s assets. “The law of large numbers is working against Berkshire,” the managers say in their annual report. “We think Berkshire’s growth rate will be respectable in the future, but not torrid.”
Taking Berkshire’s slot as the top stock holding, at 14% of assets, is Valeant Pharmaceuticals International (VRX), just the kind of niche business Sequoia loves. Instead of spending a lot on research and development, Valeant buys up older, brand-name drugs, as well as generic and over-the-counter drugs. Many are steady sellers in niche categories. The firm sells heavily in emerging markets, where its edge is its products’ reputation for safety. At $44.39, the stock trades at 12 times earnings per share for the coming 12 months.
Sequoia typically holds big positions in a handful of stocks and, in all, owns just 31. “Our goal will always be to concentrate an outsized portion of our capital in a relatively small number of businesses that we’ve studied intensively,” the managers say in their annual report. On average, the fund holds stocks for more than seven years.
Sequoia may not be quite as good in the future as it has been in the past. Its long-term record would be hard for any fund to match. But I think investors who buy shares now will be glad that they did.
Note: Come back next week for the the second installment of a five-column series on my favorite low-risk stock funds. Or sign up for an E-mail alert to be notified of all my new columns as soon as they're available.
Steven T. Goldberg (bio) is an investment adviser in the Washington, D.C. area. He owns shares of Berkshire Hathaway.