February 24, 2015

by Larry Swedroe

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Looking at its 35-year track record, some now consider the Sequoia Fund (SEQUX) an anomaly; it is an actively managed fund that has persistently generated positive risk-adjusted returns, outperforming its peers and its benchmark. Should investors expect this outperformance to persist?

The Sequoia Fund has long been one of the foremost names in mutual funds. Morningstar reports that, as of the end of January 2015, the fund had more than $8 billion in assets.

[drizzle]The fund maintains a reputation as a value-oriented investor forged in the mold established by Benjamin Graham and David Dodd. In a 1984 speech Warren Buffet gave in honor of the 50th anniversary of the publication of Graham and Dodd’s book, Security Analysis, he identified Sequoia as one of “The Superinvestors of Graham-and-Doddsville.” The fund currently carries Morningstar’s coveted five-star rating.

From its inception on July 15, 1970 through December 2014, the fund returned 14.54% per year. Compare that to a 10.98% per year return for the S&P 500 Index. Not only did Sequoia provide much higher returns than the S&P 500, but its risk-adjusted returns were also much greater. For the period from 1971 through 2014, Sequoia’s Sharpe ratio was 0.57 versus 0.40 for the S&P 500.

The fund’s reputation certainly seems well deserved. Before drawing any firm conclusions, however, let’s dive deeper into the fund’s performance. We’ll begin by analyzing data to determine the factors to which the fund was exposed and whether or not it generated risk-adjusted alpha. The data is available beginning in February 1980.

To start, we’ll perform a three-factor analysis (beta, size and value). The table below provides the factor loadings and alpha from February 1980 through December 2014.

2/1980-12/2014 Market (Beta) Size Value Annual Alpha
SEQUX 0.71 -0.16 0.29 2.63
t-stat 23.3 -3.2 5.9 1.7

 

Not surprisingly, the three-factor analysis shows the fund tended to buy large value stocks and generated an annual alpha of 2.63%. Although the alpha was not quite statistically significant at the 5% confidence level, it certainly was economically significant.

Next, we’ll look at the performance for the last 15 calendar years, 2000 through 2014, to see if there was a trend in the fund’s ability to generate alpha.

1/2000-12/2014 Market (Beta) Size Value Annual Alpha
SEQUX 0.62 -0.16 0.41 4.39
t-stat 14.0 -2.2 6.3 1.9

 

We see that the fund’s annual alpha actually was higher over the most recent 15 years at 4.39%. The loadings show that it continued to stick to its knitting as a large value investor. The alpha came very close to being statistically significant at the 5% confidence level.

We’ll now move to a four-factor analysis, adding the momentum factor. We begin with the analysis for the period beginning February 1980.

2/1980-12/2014 Market (Beta) Size Value Momentum Annual Alpha
SEQUX 0.70 -0.18 0.26 -0.09 3.52
t-stat 22.0 3.7 5.3 -2.9 2.2

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