A mutual fund that has been making news lately is the Sequoia fund (ticker SEQUX). The fund has an enviable long term track record with its roots tracing to none other than Warren Buffet. Unsurprisingly, the fund’s long term success resulted in substantial asset growth. Through year end, Morningstar reported $5.5 billion under management.
Unfortunately though, for the fund and its investors, the last year has been a disaster. The fund’s one year return is negative by nearly 30%, this while the markets are generally flat or down slightly. Recently, the manager of the fund has resigned.
How does something like this happen and, more importantly, how can investors avoid situations like these? Here are the takeaways:
- The fund became overly concentrated in one stock. Valeant Pharmaceuticals comprises about 30% of the fund’s holdings and Sequoia owns about 10% of the outstanding stock in Valeant. As the Wall Street Journal notes, as Valeant goes so goes Sequoia. Unfortunately for Sequoia’s investors, Valeant has been dealing with various issues, including possible accounting fraud. When a fund gets so concentrated that its performance is substantially tied to one or two holdings, there is simply too much risk present.
- Funds and their fund managers change over time. Successful fund managers get rich and may have less of a fire in their belly. Company cultures change and with that their investment process can change over time, often not for the better. There is some evidence that the Sequoia fund managers developed too close of a relationship with Valeant’s CEO (which likely negatively affected their diligence process).
- Past performance is over rated. The list of once great funds that turn mediocre or worse is a long one. When choosing funds, past performance is simply one part of the decision to buy. In fact, we feel that the two most important factors in choosing a fund are a sound, disciplined process and below average fees charged by the fund. These two factors at least enable the fund manager to have a chance to perform well relative to their benchmark.
- Stories like these hammer home the mantra that indexing should be the default for an investor wishing to diversify appropriately. In almost all periods, broad based index funds avoid idiosyncratic risks like the ones taken by Sequoia. This isn’t to say that actively managed funds don’t have their place. They certainly do. But it’s crucial to understand the manager’s process, what the fund owns and why so you can ascertain risk levels taken by owning it.