By Chuck Jaffe, MarketWatch
An earlier version of this story, published March 26, misstated the name of former Sequoia Fund manager Goldfarb. The story has been corrected.
In the stock market, there are bad times — and then there is what the Sequoia Fund is going through.
Bad doesn’t even begin to describe the situation for Sequoia /zigman2/quotes/209100218/realtime SEQUX +1.55% one of the most legendary mutual funds, which has seen its reputation torched by a bad bet on a controversial stock. The fund’s fall from grace culminated in the resignation of a co-manager after a 45-year career with Sequoia’s management company.
Robert Goldfarb, chief executive officer at Ruane, Cunniff & Goldfarb and co-manager of Sequoia, resigned his fund duties last Wednesday, with the fund’s board — which went through its own shake-up last fall — apparently deciding it was time to give new blood a chance.
But making things right at Sequoia will take more than the promotion of some members of the senior management team. Moreover, the fund’s actions have left its shareholders in the worst possible state: confusion.
Fund investors who buy a traditional actively managed fund are taking a leap of faith in trusting management. They recognize that all funds go through tough times, but want managers to provide clear leadership that makes them comfortable staying the course.
Sequoia has been a stellar example of how this is supposed to work. Since the fund was started in 1970 by two associates of famed investor Warren Buffett, Sequoia’s per-annum return of 14% crushes the S&P 500’s /zigman2/quotes/210599714/realtime SPX +1.45% annualized average gain of 10.8%; over the last 45 years, thanks to the effects of compounding, the fund’s cumulative return more than triples that of the index.
The difference was nothing fancy or tricky. Sequoia has always followed a non-diversified buy-and-hold strategy, where management has worked hard to pick a few stocks that it wants to hang onto for Buffett’s “favorite holding period” — forever.
Indeed, when investment researcher Morningstar Inc. first started evaluating funds in the mid-1980s, analysts there privately used a “Sequoia-Steadman” standard, effectively comparing other funds to what they considered the best fund in the industry — Sequoia — or the worst, the now-defunct Steadman Funds.
Today, however, Sequoia itself has been acting more like Steadman. It posted a dismal 7.3% loss in 2015, which has been followed up with a decline of 11.6% so far this year, both returns near the bottom of the fund’s large-growth peer group.
But the real problem has been Sequoia’s management stubbornness, infighting, and governance issues, all centered around the fund’s investment in controversial Valeant Pharmaceuticals International , which at one point last year accounted for 30% of the $5.6 billion fund’s assets (it’s closer to 20% recently).
In a statement in early March, Sequoia calculated “that Valeant contributed -6.3% to Sequoia’s return of -7.3% for .”
Valeant stock has dropped by 85% in the last six months as the company’s pricing strategies and distribution practices led to congressional inquiries and federal investigations. When the drugmaker recently slashed its 2016 earnings outlook, the stock lost half of its value in a single day.
Amid massive debt and Valeant’s myriad other problems, there’s been a shake-up of top management at Valeant, and activist investor Bill Ackman was added to the board.
Goldfarb, apparently, was Valeant’s big supporter at Sequoia — as he pushed to increase the fund’s stake in Valeant last fall, two independent directors resigned.
Now Goldfarb is out. David Poppe, Goldfarb’s co-manager for the past decade, will serve as lead manager of the fund, supported by the firm’s senior analysts, some of whom have been at the firm for decades .
“They made it sound like it was just the two guys making all the decisions, and now more decisions will fall to the senior analysts,” said Charles Rotblut, a vice president for the American Association of Individual Investors, who was a Sequoia shareholder for years until bailing out late last year. “Now it sounds like they are changing management structure, like they are saying, ‘We shouldn’t have let these guys run amok,’ or ‘We needed more diversity in our opinions.’”
Rotblut added: “It’s unclear what they are going to do or how the fund is changing now, so this is a bad look. … Uncertainty with the high expense ratio for active management is just not a good combination.”
Sequoia is hardly alone as a stellar performer hitting hard times, it is simply the most recent example since the Fairholme Fund /zigman2/quotes/200889155/realtime FAIRX +3.41% , where star manager Bruce Berkowitz has posted mostly horrible results over the past six years (despite the fund’s topping its peer group in 2012).
In its letter to shareholders, Sequoia management expressed optimism that the fund will rebound from current problems the same way it has recovered from other periods of underperformance.
That’s what every manager hopes for during tough times. But the question is whether shareholders are willing to stick around. Once management looks like it is flailing — which it looks like now — even a superior long-term record can’t calm investor nerves. At that point, even the best fund historically feels like a bad bet for the future.