Sequoia Fund’s Ruane, Cunniff & Goldfarb Investor Day 2016 transcript. Some interesting comments about Valeant – see the full transcript below.
David Poppe: Good morning. I want to welcome all of you and thank you for coming today to our annual investor meeting. Greg Alexander recalls Bill Ruane holding a meeting in his office over 30 years ago with about a dozen or so Sequoia shareholders. I apologize for the crowded conditions today and the fact that some of you may have to watch the meeting from an overflow room. We booked this ballroom many months ago. We knew we had outgrown the St. Regis ballroom, but we did not anticipate quite this level of interest.
We know the big crowds today are the result of our disappointing performance over the past eight months. You are here because you are concerned about your investments with us and about our management transition. We fully expect to hear criticism and pointed questions this morning. However, in light of the important changes that have occurred here, we are going to add a bit more structure to the meeting this year.
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I will begin by talking for a bit about the state of our firm: what is changing and what is too important to change. My colleague, John Harris, who will be joining me on the Sequoia Fund Board of Directors, will discuss our investment results. We will talk about our investment process, and I will try to tackle some of the questions clients have been asking us about Valeant. The changes to the meeting structure are designed to address directly what we think are the major issues facing our firm: what the leadership will look like going forward, what happened with Valeant, and how our research process works.
In all, these reports should take about an hour. After that, we expect to have 90 minutes to answer your questions.
Before I start on the state of our union, let me remind everyone that this is a voluntary meeting. We enjoy doing it and we plan to keep doing it. We get to see many good friends and it is healthy for us to stand up in front of you and talk about our process and our results. It is also good for us frankly to have so many clients and friends see the depth and strength of our team. But we do not invite the public or the press, and we ask everyone to honor the off-the-record nature of this gathering by not taping, transcribing, tweeting or reporting about it. This meeting has always been for our clients, and we will issue an edited transcript over the summer as we have always done.
Okay, with that, where are we today? We have managed through a two-year transition in two months. During that time, the analyst team, our director of client services, Jon Gross, and I have spoken to more than 500 clients, many of you in person. And without minimizing the stress we have created for you, we feel that we are moving forward and each day spending a little less time on client-facing activity and more time on investment research. Both are important, but ultimately stock-picking will drive your returns.
We have lost some clients and some assets. You have probably read about that, but we remain a very strong firm. We have nearly $20 billion dollars in assets under management, including $5 billion dollars in the Sequoia Fund, more than $9 billion dollars in separate accounts that are managed in similar fashion to the Sequoia Fund, and about $5 billion dollars in the private investment partnerships, managed by our colleagues John Harris and Greg Alexander. As our size indicates, we remain very healthy. We have retained all of our key employees and our entire research budget.
We started the year with 22 people in stock research. Bob retired and our lead Valeant analyst resigned. The other twenty people in research remain in place. We intend to add research analysts over the course of the year. And, for the record, our most important employee, Jo Ann Chiarelli, is staying. For those of you who do not know her, Jo Ann was Bob’s assistant for 27 years and is one of the unsung heroes of our firm. The research team has been together for years. Nearly all of the senior people were handpicked by Bill, Rick, and Bob. We benefit enormously from the culture Bill Ruane and Rick Cunniff created and from the great long term results they, and we, have generated for clients. We have been deeply moved by our clients’ loyalty and long-term perspective, and we know that is a reflection on Bill, Rick, and Bob. We believe we offer an unusually good work environment for someone who is passionate about long-term investing. Our stability over many years means our people have internalized our values and priorities. There is no cultural shift that is happening or that needs to occur. We simply continue doing what we do well.
Our investing philosophy will not change. We remain committed to a bottom-up, research-driven process that results in a focused portfolio of 25 ? 35 businesses that we know very well. Bill Ruane liked to say that your six best ideas in life will do better than all your other ones. And you should expect the top half dozen or so companies in your portfolio to make up a large chunk of the assets. During Bob Goldfarb’s eighteen-year tenure as CEO, we broadened our research focus and added more analysts to our team and more positions to Sequoia. But we remain committed to the idea of a focused portfolio of equities selected after intensive research and held for years.
We have written to you that we have established an investment committee. That feels like a change. Many clients ask how the committee will work, and I hear two common remarks. One: Committees do not work. Two: Investing is a business of individual talent— One portfolio manager creates the value; others support that portfolio manager. Let me point you back to history. From at least the 1980s through 2002, four people signed all the Sequoia mailings to clients: Bill Ruane, Rick Cunniff, Bob Goldfarb, and Carley Cunniff. All four were on the Sequoia Fund Board. When Carley retired, I replaced her on the Board. My predecessors did not call it a ‘‘committee,’’ but there has always been a collaborative process here. Bob and Bill worked very closely together for many years. But Rick and Carley had strong voices and they weighed in. Bill always believed the lead analyst on a project had to have a say in the investment, and we have always been run that way. I can tell you that in 2000, Bill wanted to buy TJX and Ross Stores, and I was his lead analyst on that project. I told him buying Ross was a bad idea, as TJX was, in my opinion, the better company. Since then, TJX has risen in price by almost fifteen times our original cost. But Ross has done about the same. I wish we had owned them both! But the point is, Bill listened to the analyst. As the years passed—and unfortunately we lost Carley then Bill then Rick — Bob and I became Sequoia co-managers. We still ran the firm so that two portfolio managers and the lead analyst on each security worked closely together on new ideas and needed to agree to add a position to Sequoia.
The new structure simply formally acknowledges this way of working with the difference that three senior analysts, Chase Sheridan, Trevor Magyar, and Arman Kline, will be a second set of eyes reviewing research and portfolio positions, working with me, John Harris, and the lead analyst on a specific stock. This is not different from the way we have always worked. And let me note that Chase, Trevor, and Arman among them have more than 30 years of tenure here and are more than ready for additional responsibility.
On the question of individual talent, Bill Ruane and Rick Cunniff both managed individual client portfolios for decades with different styles and great results. Bob Goldfarb had a brilliant career. Greg Alexander has outperformed the Standard & Poor’s Index in his partnerships over more than 25 years, investing much more globally than Sequoia does. John Harris has outperformed the Index in his partnerships since its launch in 2008, again with a more global focus.
We have two prominent alumni who left to launch their own investment businesses and who have outperformed the Index over many, many years. And several of us have managed portfolios internally with good results. So two points: First, we attract and retain a lot of talent. Bob made it a priority over the past decade to invest in research, but we have always been a good home for long-term investors. Second, we have a good process and a focus that has allowed our people to invest well over many years. We push and push on research, sometimes to the point of diminishing returns. And generally, if you make decisions based on large amounts of information you will outperform a person who makes decisions with less information. And information that has been screened by more than one set of eyes and with some skepticism should yield good results.
I would also note that the best ideas in Sequoia have been bubbling up from the research team for more than a decade. I feel good about our creative engine and our analytical rigor. And to repeat, I do not believe our investing personality will change. Bob Goldfarb is a brilliant man and we will miss him, but he was not the primary idea generator at Ruane, Cunniff for the past decade.
I want to discuss one other significant change with you, which is that we are going to cap concentration in a single position at 20% going forward for Sequoia. There could be some exceptions for Berkshire Hathaway for clients with separately managed accounts. We have edited our prospectus and our SEC documents to reflect this change. This comes after much deliberation amongst ourselves and with our clients. We could leave some performance on the table by selling a great company too early, but when we look back at our history, we have had a number of positions get to 20% over the years and, with the notable exception of Berkshire Hathaway, by the time they got that large, their era of outperformance was generally drawing to a close.
So that I am clear, let me say that I have enormous respect for Bob Goldfarb. He was a strong voice at our firm, and for a decade he and I were a good team. He did an enormous amount for me personally, for which I will always be grateful. But we have been through an extremely stressful period, and at age 71, Bob elected to retire. Two months later, it is clear to me that this was the right decision for him and for us. We wish him well, but we also look forward to the future with determination, optimism and vigor.
Before I finish, I want to introduce the entire research team. You will be hearing from many of them over the course of the morning: Saatvik Agarwal, Girish Bhakoo, Peter Bin, Jonathan Brandt, Arman Gokgol-Kline, Jon Gross, Director of Client Services, Jake Hennemuth, Duncan Horst, Eileen Jang, Antonius Kufferath, Trevor Magyar, Will Pan, Terence Paré, Chase Sheridan, Inder Soni, world famous author Greg Steinmetz, Stephan van der Mersch, Marc Wallach, and I think all of you know Greg Alexander and John Harris, who are up here with me.
Next, let me introduce the Sequoia Fund directors: Board Chairman Roger Lowenstein, Tim Medley, and Bob Swiggett. Eddie Lazarus could not be here this morning. I want to take a minute to thank the Directors for their hard work over the last eight months. It has been a challenging period for us and for them, and they have served with energy and dedication. They care tremendously about Sequoia and have been good advisors to me and good stewards for you. With that, I am going to ask John Harris to give a presentation on our performance history. Thank you.
John Harris: This is the point where I think you are supposed to say ‘‘Thank you’’ to the person introducing you. But it is interesting; I was talking to my mother the other day, and your mother always knows when you are trying to shoo her off the phone. ‘‘So you are trying to get off the phone with me, what is the problem?’’ I said, ‘‘A busy week, Mom, we have got a lot to do. We have got our Investor Day, and I have got to give a talk.’’ She said, ‘‘What do they have you talking about?’’ I said, ‘‘I am going to talk about the performance.’’ And there is a long pause, then she says, ‘‘They must not like you very much!’’ ‘‘Well, gee thanks Mom. I hadn’t thought of it that way.’’
I do not know quite what the message is in putting me up here, but here I am and we are going to talk a little bit about performance. Before we do that, I know a lot of you in the room. I do not know all of you. So, I am just going to take a second to give a brief overview of my background and how I got to Ruane, Cunniff; so hopefully you know me a little bit better.
I got my undergrad degree at Harvard, where I graduated in 1999. I worked for Goldman Sachs for a couple of years. After that, I worked for the private equity firm Kohlberg Kravis Roberts for a couple of years. In 2003, I joined what was then called Ruane, Cunniff. I spent my first five years at the firm working on our Sequoia Fund team. I was responsible for our investments in O’Reilly Automotive, MasterCard and Hiscox, and I inherited coverage of what at the time was our large investment in Progressive Insurance. In 2007, I started a family of private partnerships, which, as David said, is affiliated with Ruane, Cunniff & Goldfarb in the same way that Greg’s partnerships are and which has a broader, more global mandate than what we pursue in the Sequoia Fund. I sit on our management and investment committees, and, again as David said, I am going to join him on the board of the mutual fund.
Okay, as you know, we measure our performance against the passively managed S&P 500-stock index. And we earn our keep by producing more wealth for you over the long-term than you could get from an index fund based on the S&P. Over the very long term, that is from inception in 1970 until 2015 and over the 10- and 15-year periods ending in 2015, I am happy to report that we have outperformed, which you probably already know. Our more recent performance over five years and this last quarter is the reason why my mom was convinced that all these guys do not like me as much as I think they do.
We are going to spend some time putting our recent performance into the context of the market cycle, but before we do that, I just want to stop for a second and be very clear: We are every bit as frustrated with our recent performance as you are, frankly, maybe even more so. This is our life’s work and we work hard at it. To put in all the late nights and weekends and the 6:00 AM flights and all the weeks on the road away from the family and to come up with a set of numbers over the recent past so short of what you expect in the light of our long term record is an enormous disappointment. And frankly, while we outperformed modestly over the ten-year period ending in 2015, we do not feel much better, in part because the year to date performance erases that narrow edge of outperformance. Nobody came here to win by a nose or to be average. And they certainly did not come here to be below average. I can tell you personally the reason that I came here thirteen years ago was that I wanted to be a part of something special. I wanted to have a hand in helping to perpetuate what is still to this day one of the great records in the history of the mutual fund industry.
This raises some obvious questions: What was it that helped create our long-term record? Whatever those things are, are they still a part of this firm? Are they still a part of this team? Hopefully when I am done talking at you, and when my partners are done talking to you, and when we are done answering all of your questions, you will have a better sense for the answers to those questions, which you absolutely deserve.
A good way to get a sense of the ebb and flow of long-term fund performance over market cycles is to look at the rolling five-year compound annual rates of return versus a market bogey. The performance of a concentrated fund like Sequoia will by design vary from the market return day to day, week to week, and year to year. By looking at rolling five-year periods, you can get a sense of whether the end-result over a reasonable period of time is worth the worry of going against the crowd. When you work out all these numbers for Sequoia and the S&P 500, you find a pattern which, if you are familiar with the way we invest your capital, probably should not be surprising: Nearly all of the time, we outperform over rolling five-year periods. And we tend to look our best when markets look their worst, and when markets look their best, such as during the bull market peaks of 2000 and 2007, we tend to look our worst. Now, we take a lot of pride in the fact that there are not many periods when we have run behind the rabbit over a five-year stretch.
What is interesting when you do this calculation for the most recent bull market cycle beginning in 2013, is we kept up longer and performed better than we had in the previous cycles, even beating the market when it looked its best. That was really the impact of Valeant in its heyday, and obviously we are a long way from the heyday now. And today, as the market has continued higher, we have slipped behind on a rolling five-year basis.
If you step back for a second, there is an interesting observation to make about our performance by this particular yardstick. If you had not gotten your Wall Street Journal for the last year, as I sometimes wish I had not, you could easily come to the conclusion that it is sort of business as usual at Ruane, Cunniff. In other words, with the market looking peak-ish, Sequoia’s rolling five-year average return is lagging behind like it has at times like this in the past. Now I know it does not feel like business as usual, and part of the reason it does not feel that way is that sometimes the way you get somewhere matters every bit as much or more as where you actually get to. To illustrate the point, just indulge with me for a second in one of my most favorite recent pastimes: closing my eyes and pretending that I had never in my life heard the words Valeant Pharmaceuticals. Imagine instead that I told you that six years ago we put about 5% of the fund’s capital in a stock that has subsequently gone up about 40%. Then nine months ago, we made another investment in the same company XYZ, a much smaller investment, but that one went down 75% or 80%.
Now obviously, neither of those is a good outcome. Any time you lose 80% of anything, I do not care how small an investment it is, that is a bad thing. And to have made an investment six years ago that went up 40% may count as making an absolute return, but you have not had a good result: I do not know what the market is up over the last six years, but it is probably 100% or something like that. Clearly, those two outcomes are bad. But the important point is that they are not necessarily unusual outcomes. I hate to say this, but I can think of probably three times just since I joined this firm that we made small sort of 1%-ish investments in things that went down 50% ? 60% ? 70% ? 80%. These are illustrious names like SMA Solar and First Solar. Serco would be another one. These are things that have happened before, and it is not unusual for us to buy stocks that go up less than the index.
The big thing left unsaid here is the stock we are imagining is the all too real Valeant, which we bought six years ago and which is now up less than the Index, but that between points A and point B went up about fifteen times then went down 90%. That is disappointing and embarrassing. But from the perspective of performance, what matters is what happened at the end points and not necessarily how it happened. Of course, the what of what happened in this case is not a good result. But it is also a long way from the worst thing that can happen to you as an investor.
In other words, putting the highs and the lows of Valeant to the side, the fact that the fund is lagging behind a bull market runs true to our form. We tend to lag a strong market. And we tend to lead a bear market as we did in 2000 to 2002 and in 2008. The big unknown is when this bull market will end and the next bear market will start. Of course, we do not know any more about that than you do, and obviously past performance is no guarantee of future results and all the usual caveats. But I think it is a reasonable expectation that given the businesses that we own and given the cash balance that we carry in the portfolio, it is probably more likely than not that if the next bear market were to start tomorrow, we would get a result similar to the one that we got in the last two bear markets, and we would outperform by some meaningful margin. But of course we will just have to wait and see.
If you have lived the reality that we have lived for the last nine months and read all the headlines that we have read, it is frankly hard to imagine that this firm has ever looked any dumber than we all feel right now. But the fact of the matter is that we have, three different times! As wide as the gap is today between Sequoia and the Index, it was wider still in 1973, 1980, and 1999. Of course, each of those episodes had its own driving forces, and there is absolutely a debate to be had about whether some of those forces are more or less benign in nature than others. But the important point for our purposes today is that as painful as these periods may be, they are a natural outgrowth of doing things the way that we have always done them. Since the first day that Bill Ruane opened the doors, and it is just as true today as it was then, we have always believed that if you do good investment research and you make generally good judgments, you will be well served over time by concentrating your capital in your best ideas. And certainly if you look over the sweep of the history of Ruane, Cunniff, there is no question that concentration has been a big help to us and to you over time.
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