In 1969, after more than a decade of running investment partnerships, a young Warren Buffett (Trades, Portfolio) decided he was going to close down his investment vehicles because he was struggling to find opportunities in the market.
Rather than shutter his businesses altogether and return the money to investors, however, he decided to go out and find another manager who would be willing to take his place, a manager that he trusted to follow in his footsteps and continue to grow the wealth of his clients.
The manager Buffett settled on was Bill Ruane.
The beginnings of the Sequoia Fund
According to the Sequoia Fund's website, Ruane went on to set up the fund with his partner Rick Cunniff in 1970 "in the belief that they could outperform the stock market by investing in great businesses selling at reasonable prices and staying with them as long as they remained attractive."Â
Unfortunately, during the first few years of the fund's life, the managers struggled to make an impact. Between inception and 1973, Sequoia underperformed the S&P 500 by around 10% per annum.
As Buffett described in his now famous essay, "The Superinvestors of Graham and Doddsville":
"When I wound up Buffett Partnership, I asked Bill if he would set up a fund to handle all of our partners, so he set up the Sequoia Fund. He set up at a terrible time, just when I was quitting. He went right into the two-tier market and all the difficulties that made for comparative performance for value-orientated investors."
He went on to say:
"Bill was the only person I recommended to my partners, and I said at the time that if he achieved a four-point per annum advantage over the Standard and Poor's, that would be a solid performance."
After a few years of underperformance, the Sequoia Fund roared back in 1975, outperforming the S&P 500 by around 23% and then 48.7% in 1997.
Sticking to the strategy
According to a letter to Sequoia's partners dated 1974, the year the fund's performance record finally started to turn around, Cunniff and Ruane note that the "much heralded two-tier market situation" had become blurred as a number of the high-flying Nifty 50 stocks registered sharp declines during first few weeks of 1974.
After giving an overview of the current situation, the letter went on to say, "The most that can be said is that sobering events such as these have rekindled interest in a broader list of securities." They also noted, "Our stocks have rebounded from what had to be ridiculously low prices, relative to both assets and earnings, that was seen late last year."
After an overview of the market situation, Ruane and his partner declared inflation was the greatest threat to investors' capital at the time, and the best way to protect your portfolio against the scourge of inflation was to acquire "well-selected common stocks" trading at a discount to assets, "which can only be worth more as inflation proceeds."
The fund's letter concluded:
"Two-thirds of the stocks in the Sequoia Fund's portfolio are selling below stated asset value, and their market values in our opinion are well below the values that would be obtained in realistic merger negotiations or cash sales of entire companies. We will continue to concentrate on stocks which meet our standards of value regardless of fads because we believe they offer the best opportunity to fight the investor's battle against inflation."
This is a fascinating insight into how Sequoia's managers were thinking at the time and the way they approached valuation in a market that had been moving against them for years.
Over the next several years, the focus on high-quality stocks trading at a discount to asset value paid off handsomely and provided Sequoia's investors protection from inflation for many years to come.
Read more here:
- Does Warren Buffett's Long-Term Investment Focus Hold Him Back?
- Looking Back at Sequoia and Progressive
- Hedge Funds' Favorite Bets in 1st-Quarter 2019
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