Warren Buffett recommended the Sequoia Fund when it opened in 1970, and that proved to be a smart call. The fund’s performance beat the U.S. stock market over the past four decades, in part because it had a lot of its money in Buffett’s diversified and highly regarded company, Berkshire Hathaway. That all changed in 2010, after Buffett warned that Berkshire wouldn’t grow as fast as it once did. The managers of the $4 billion Sequoia Fund cut their reliance on the stock almost in half. That proved to be another smart call. Sequoia delivered a 13 percent return in 2011, better than 99 percent of its value-stock fund peers, according to data compiled by Bloomberg.
Like Buffett, Sequoia’s managers look for high-quality companies with competitive advantages, and they hold their investments for long periods. One crucial difference: While the scale of 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 percent of peers over the past 10 and 15 years, according to research firm . From 1970 to 2010, the fund returned 14 percent annually, compared with 11 percent for the Standard & Poor’s 500-stock index. “They have the kind of portfolio Buffett might have if he ran a mutual fund,” says Steven Rogé, a portfolio manager with Bohemia (N.Y.)-based R.W. Rogé, which holds shares in Sequoia.
Sequoia Fund was founded by Richard Cunniff and William Ruane, a friend of Buffett’s since both studied under legendary value investor Benjamin Graham at Columbia University in 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 writes 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.”
Ruane closed 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 Ruane’s 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. The fund is now managed by David Poppe and Robert Goldfarb, who didn’t respond to a request to be interviewed.
Since Ruane’s death, the firm has hired more analysts and added more holdings. Berkshire represented 11 percent of Sequoia’s holdings as of Sept. 30, down from 20 percent at the end of 2009 and 35 percent in 2004, according to fund reports. In 2011, Buffett bought shares of and , two companies Sequoia already owned.
Valeant Pharmaceuticals International, the fund’s largest holding, gained 65 percent last year. At a 2011 investor meeting, the fund’s managers emphasized Valeant’s 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 firm’s chief executive officer, J. Michael Pearson. Goldfarb told investors that over time he has become convinced that the right executive is crucial to a business’s success. “We’re betting more on the jockey and a little less on the horse,” he said in May at the fund’s annual meeting.
While the fund’s Berkshire Hathaway stake has been enormously profitable, it has been a drag on the fund’s returns in recent years, according to Kevin McDevitt, an analyst for Morningstar. Over the 20 years through December, Berkshire outperformed Sequoia by 2.6 percentage points a year. Yet over the past five years Sequoia rose 4.5 percent a year, compared with an annual gain of 1 percent for Berkshire. “There was a time when you could have said they were riding Buffett’s coattails,” says McDevitt. “That’s not the case anymore.”