An epic win­ning streak on Wall Street — and one ugly loss

The Se­quoia Fund, with the im­pri­matur of War­ren Buf­fett, re­turned bil­lions to in­vestors. Then it bet big on Valeant.

The Washington Post Sunday - - BUSINESS - BY THOMAS HEATH

The fi­nan­cial whizzes co­cooned in the serene of­fices of the Se­quoia Fund atop one of New York’s iconic of­fice build­ings seem far re­moved from the noise of the city far be­low.

But the 47-year-old mu­tual fund known as much for its ties to bil­lion­aire War­ren Buf­fett as for its un­canny stock picks that cre­ated mas­sive wealth for clients — re­tire­ment funds, pen­sion funds, uni­ver­sity en­dow­ments and reg­u­lar-Joe in­vestors — has had to de­scend from its lofty perch in the past two years and res­cue its good name.

A big mis­cal­cu­la­tion on one stock, Valeant Phar­ma­ceu­ti­cals In­ter­na­tional, has cost the Se­quoia Fund bil­lions of dol­lars and com­pro­mised its rep­u­ta­tion for mar­ket-beat­ing per­for­mance earned over decades.

The re­build­ing process comes at a time when in­vestors are leav­ing stock-pick­ing funds such as Se­quoia for in­dex-based mu­tual funds, which track a fixed bas­ket of stocks. Value stocks such as the ones Se­quoia seeks out are find­ing them­selves less loved by a bull mar­ket that is on the hunt for the next Ap­ple or Face­book.

Se­quoia grew to ma­tu­rity un­der the glow of Buf­fett, the folk-hero money mind whose ste­ward­ship of Berk­shire Hath­away prompted a na­tional fol­low­ing based on the virtues of com­mon-sense in­vest­ing and avoid­ing mis­takes.

The Se­quoia Fund has long stood near the top of the Wall Street pyra­mid. It en­joyed a rep­u­ta­tion for so­bri­ety, trans­parency and a re­sis­tance to volatil­ity, which drew blue-chip clients such as The Wash­ing­ton Post. The news­pa­per for years has listed the Se­quoia Fund among its 401(k) op­tions. (This re­porter has been a mod­est Se­quoia in­vestor for 20 years.) The Valeant stum­ble has re­ver­ber­ated. “It was quite painful, but most clients made money on Valeant,” said chief ex­ec­u­tive David Poppe, sit­ting in a con­fer­ence room over­look­ing the re­gal Plaza Ho­tel, with leafy Cen­tral Park and the Bronx in the


Se­quoia bet — and bet big — on Valeant. It stuck with the shares even as Valeant was bat­tered by Wall Street and by re­lent­less me­dia cov­er­age of its strat­egy of us­ing debt to buy drug com­pa­nies, then lay­ing off em­ploy­ees, do­ing away with re­search and jack­ing up prices — which re­sulted in em­bar­rass­ing con­gres­sional hear­ings and fed­eral in­ves­ti­ga­tions.

Se­quoia’s re­turns even­tu­ally tum­bled. Its as­sets un­der man­age­ment have been halved from $8 bil­lion pre-scan­dal to $4.2 bil­lion, with a big chunk at­trib­ut­able to a nose-dive in Valeant stock. It fell from $257 two years ago to less than $15 now, a loss of more than 90 per­cent.

Look­ing up from the wreck­age, Berk­shire Hath­away Vice Chair­man Char­lie Munger called Valeant “a sewer” and its busi­ness prac­tices “deeply im­moral.” Buf­fett called it a “Wall Street scheme” with an “enor­mously flawed” busi­ness model.

The Se­quoia Fund’s Morn­ingstar rat­ing, a re­spected met­ric in the mu­tual-fund in­dus­try, dropped from gold to bronze. Long­time fund co-man­ager Bob Gold­farb, known for con­trar­ian views that un­earthed stock gems, re­tired. Through a spokesman, Gold­farb de­clined to com­ment for this ar­ti­cle.

Se­quoia once en­joyed such pres­tige that it closed it­self to new in­vestors. Now, af­ter the loss of some ma­jor in­vestors be­cause of Valeant, Se­quoia has in­stalled a more rig­or­ous ap­proach to pick­ing stocks and sell­ing them. The com­pany’s an­nual In­vestor Day meet­ings are now more ten­sion­filled af­fairs with pointed ques­tions.

“It’s fun to play on a win­ning team,” Poppe said. “Sud­denly we look like a los­ing team.”

Value in­vest­ing

To un­der­stand how and why Se­quoia bet the farm on Valeant, you need to un­der­stand value in­vest­ing.

The con­cept is sim­ple: Find the few un­der­ap­pre­ci­ated com­pa­nies that ev­ery­one else has ig­nored. When you find one that is un­der­val­ued, buy it. Buy lots of it.

Se­quoia di­rec­tor John B. Har­ris put it this way: “The crux of value in­vest­ing is this no­tion that the vast ma­jor­ity of peo­ple, the in­vest­ing pub­lic at large, tends to get things mostly right but not al­ways right. And some­times very wrong.”

“If you do very dili­gent re­search and make an­a­lyz­ing busi­nesses your life’s work rather than just a hobby,” he said, “ev­ery so of­ten, you will be able to come to a pretty firm con­vic­tion about what the fu­ture holds for an in­di­vid­ual busi­ness. Ev­ery once in a while, you will be able to pay a price that’s far be­low what it’s truly worth.”

Go back to 1969. That’s the year Wil­liam J. Ruane and Rick Cun­niff, friends and grad­u­ates of the Har­vard Busi­ness School, founded a stock-pick­ing firm that be­came known as Ruane, Cun­niff & Gold­farb. A year later, the found­ing part­ners cre­ated their flag­ship mu­tual fund, Se­quoia.

Ruane, Cun­niff has al­ways had two parts: the Se­quoia Fund and, sep­a­rately, in­di­vid­ual clients that in­clude fam­i­lies, in­di­vid­u­als, pen­sions, foun­da­tions and en­dow­ments. The port­fo­lios of the Se­quoia Fund and the pri­vate clients are vir­tu­ally the same.

“We think of it as one busi­ness, one client, one port­fo­lio,” Poppe said.

Ruane and Buf­fett’s life­long friend­ship be­gan at an in­vest­ment sem­i­nar led by long­time Buf­fett men­tor Ben­jamin Gra­ham, a pro­fes­sor at Columbia Uni­ver­sity who was called “the fa­ther of value in­vest­ing.”

Buf­fett, Ruane, Cun­niff and a cadre of other Gra­ham dis­ci­ples ran with the value in­vest­ing ethos, build­ing names and for­tunes for them­selves. Buf­fett and Munger are bil­lion­aires.

The first years were dif­fi­cult, but by the mid-1970s, Ruane, Cun­niff found its foot­ing by dis­cov­er­ing un­no­ticed pub­lic com­pa­nies, in­clud­ing The Wash­ing­ton Post Co. (which had then re­cently gone pub­lic), In­ter­pub­lic Group and Ogilvy & Mather. In the 1980s, the firm had hold­ings in Kraft, Sara Lee and Cap­i­tal Cities. The 1990s pro­duced stakes in Fifth Third Bank, Pro­gres­sive In­sur­ance, Har­ley-David­son and John­son & John­son, all of which were sold at healthy prof­its.

Buf­fett had such faith in Ruane that he would rec­om­mend the firm to oth­ers. As re­cently as 2016, Buf­fett said at Berk­shire Hath­away’s an­nual meet­ing that he con­sid­ered him­self the Se­quoia Fund’s “fa­ther.”

“I’m the fa­ther of Se­quoia Fund in that when I was clos­ing up my [Buf­fett] part­ner­ship at the end of 1969, I was giv­ing back a lot of money to part­ners,” Buf­fett said. “Th­ese peo­ple trusted me, and they wanted to know what they should do with their money.”

“Bill, who would not oth­er­wise have done so, said, ‘I’ll set up a fund,’ ” Buf­fett re­called.

Ruane, Cun­niff re­turned the love. By the early 1990s, Buf­fett’s Berk­shire Hath­away be­came one of the Se­quoia Fund’s core hold­ings. It has stayed that way since, with its share price ris­ing from $70 to more than $200,000. Berk­shire Hath­away con­sti­tutes 11 per­cent of Se­quoia’s as­sets.

“Bill ran Se­quoia un­til roughly 2005 when he died,” Buf­fett said in 2016. “He did a fan­tas­tic job, and even now, if you take the record from the in­cep­tion to now with the trou­bles they’ve had re­cently, I don’t know a mu­tual fund in the United States with a bet­ter record. You won’t find many records that go for 30 or 40 years that are bet­ter than the S&P.”

Part of the key at Ruane, Cun­niff was to con­cen­trate on a few stocks, at first maybe eight or 10.

Even to­day, the firm’s port­fo­lio is con­cen­trated, though now the num­ber is closer to 25. That’s very few in­vest­ments for an $11 bil­lion-plus port­fo­lio. Se­quoia’s in­vest­ments in­clude very un-val­ue­like names such as Ama­ and Google par­ent Al­pha­bet. Both are widely owned stocks that are heav­ily scru­ti­nized. (Ama­zon chief Jef­frey P. Be­zos owns The Post.) Value in­vestors such as Se­quoia gen­er­ally seek ig­nored, un­der-the-radar com­pa­nies that have been mis­judged and have room to grow.

“Bill had a say­ing, ‘Your six best ideas in life will do bet­ter than all your other ones,’ ” Poppe said. “That ethos has been con­sis­tent for the whole 47 years of the firm.”

Har­ris said that “a typ­i­cal an­a­lyst can do six to eight re­ally good projects a year at the most.” Se­quoia’s 20 an­a­lysts there­fore yield about 120 or so pro­pos­als a year for con­sid­er­a­tion.

And it has worked. If you in­vested $10,000 in the Se­quoia Fund in July 1970 and never touched it, you would have had $3,961,656 on June 30, 2017. The fund is up an ad­di­tional 8 per­cent far this year.

“If your hap­pi­ness is de­fined by ‘How many ideas do I get into the fund ev­ery year?’ then you’re go­ing to be frus­trated,” Har­ris said. “You can go a year or two or three with­out putting any­thing in the port­fo­lio. If you can con­trib­ute one re­ally great idea, a big idea ev­ery five years that we can scale up and that re­ally works, you are do­ing a heck of a job.”

The com­pany tries to dis­cour­age pride of own­er­ship so an an­a­lyst doesn’t be­come hell­bent on get­ting an idea through the five-per­son in­vest­ment com­mit­tee. Still, al­phas from Yale or Har­vard aren’t likely to be happy beaver­ing away on projects that never reach fruition.

It’s not un­heard of for a Se­quoia an­a­lyst to spend a decade in­ves­ti­gat­ing a com­pany, go­ing to an­nual meet­ings, talk­ing to dozens of em­ploy­ees, man­agers, cus­tomers, sup­pli­ers.

“We fol­lowed CarMax for a decade be­fore we ever bought the stock,” Poppe said.

Har­ris vis­ited 100 stores be­fore the com­pany made a bet on O’Reilly Auto Parts, which has been a huge home run. Se­quoia bought the po­si­tion in the sum­mer of 2004 at a ba­sis of $19.84. To­day, it’s worth around $200.

“We ig­nore what­ever the daily news is, whether it’s the lat­est twist in the health-care leg­is­la­tion or the lat­est blip from the Fed­eral Re­serve,” said Roger Lowen­stein, one of Se­quoia’s out­side di­rec­tors and the au­thor of a book on Buf­fett. “They just think about what busi­ness they want to be part own­ers of go­ing into the fu­ture.”

At first, Valeant ap­peared to be an­other suc­cess story.

As Poppe put it: “Valeant and the chief ex­ec­u­tive [Michael Pear­son] had a good in­sight, which is that the U.S. phar­ma­ceu­ti­cal in­dus­try was spend­ing a lot of money on [re­search and de­vel­op­ment] and not get­ting a great re­turn on orig­i­nal re­search and de­vel­op­ment ideas.”

“What if you could build a phar­ma­ceu­ti­cal com­pany us­ing low in­ter­est rates and cheap cost of cap­i­tal to ac­quire prod­ucts in some area where the doc­tors . . . have a lot of au­thor­ity over pre­scrib­ing?” Poppe said. “That strat­egy made sense to us. And it worked for a pretty good pe­riod of time.”

But what Se­quoia mar­ried it­self to was an off­shore drug com­pany that bor­rowed heav­ily to buy other drug com­pa­nies, cut costs and re­search, then raised prices on many older drugs to as­tro­nom­i­cal heights. It quadru­pled the price of a 55-year-old drug that treats a rare ge­netic dis­or­der. The Valeant play­book re­peated this high-risk, debt-laden tac­tic through 30 ac­qui­si­tions in five years.

“Gold­farb be­came very en­thralled with the Valeant chief ex­ec­u­tive,” Morn­ingstar an­a­lyst Kevin McDe­vitt said. “He looked at Pear­son as a once-in-a-gen­er­a­tion cap­i­tal al­lo­ca­tor. That’s kind of what Se­quoia did with Berk­shire Hath­away. Berk­shire was the rock of this port­fo­lio. They tied them­selves to one stock and made it their cen­ter­piece.”

Around 2010, Ruane, Cun­niff be­gan buy­ing 34 mil­lion shares at around $19, which came to about a $650 mil­lion in­vest­ment. By 2015, that stake had risen above $8.5 bil­lion, rid­ing the arc of Valeant’s stock price to $260 per share.

Then-Se­quoia di­rec­tor Sharon Os­berg wor­ried that Valeant was too big a piece of the port­fo­lio. “Se­quoia con­tin­ued to buy when I felt it was an ex­tremely risky in­vest­ment and way too large a per­cent­age of our port­fo­lio,” Os­berg said. “It was a huge threat to the fund.”

By fall 2015, Valeant showed signs of sour­ing.

“The Valeant man­age­ment team made an ac­qui­si­tion in 2015 at a very high price,” Poppe said. “They paid for the whole thing in debt, so that added a lot of risk to the busi­ness.” But Se­quoia failed to ad­just. Gold­farb in Oc­to­ber 2015 de­cided to buy more shares, even as the stock was drop­ping by half to around $120 a share. The drop came as Valeant cut its ties with a con­tro­ver­sial mail-or­der phar­macy called Phili­dor af­ter it was ac­cused of be­ing a “phan­tom phar­macy” used to ar­ti­fi­cially boost sales. Os­berg had seen enough. “It was dur­ing a board phone call when we were dis­cussing this, and some­body, it might have been me, said, ‘You are not buy­ing more Valeant, are you?’ ” Os­berg re­called. “And Bob [Gold­farb] had just made an­other large pur­chase by the Se­quoia Fund. I re­signed the next day.”

In 2016, Se­quoia fi­nally sold its shares in Valeant in the high $20s, or for about $1 bil­lion.

Lowen­stein said he was not con­cerned with the ini­tial stakes that Se­quoia bought.

“We have had var­i­ous po­si­tions in the high sin­gle and even in the low dou­ble dig­its” as a share of the port­fo­lio, Lowen­stein said. “When, through ap­pre­ci­a­tion, it grew and be­came a much big­ger part of the port­fo­lio, each of the out­side di­rec­tors ex­pressed con­cerns.”

At the end of the day, in the world of in­vest­ing where stockso pick­ers are judged by know­ing when to take some chips off the ta­ble, Se­quoia had waited too long. Its per­for­mance took big hits for three years in a row — in 2016 by a whop­ping 18.86 per­cent­age points. Some in­vestors are still an­gry. “They made a huge mis­take,” said Steve Gold­berg, who runs Twed­dell Gold­berg, an in­vest­ment man­age­ment firm in Sil­ver Spring, Md. Gold­berg said he made money with Se­quoia but got out when Valeant started plum­met­ing. “This was lit­er­ally a drug com­pany that was do­ing no [re­search and de­vel­op­ment]. They just bought the drug and raised the price on it. A hell of a busi­ness model. Why did they buy a com­pany that wasn’t do­ing any­thing but [ac­qui­si­tions]?”

Valeant’s de­noue­ment in­cluded a tense Se­nate hear­ing; the de­par­ture of Pear­son, once the high­est-paid chief ex­ec­u­tive in Canada, at $182.9 mil­lion; crim­i­nal charges in­volv­ing fraud; and kick­backs in­volv­ing the mail-or­der phar­macy. Ac­tivist in­vestor Bill Ack­man, long a de­fender of the com­pany, even­tu­ally sur­ren­dered his Valeant shares at a $4 bil­lion loss.

How, with all its deep re­search and money minds, did Se­quoia get this so wrong?

The de­ci­sion to in­vest and stick with Valeant “was not about one per­son,” Poppe said. There is no good an­swer. “It al­most be­gins to feel like a Greek tragedy,” McDe­vitt said. “Gold­farb had been revered in the in­dus­try, and right­fully so. For years, he would get it right, even when peo­ple said it was wrong. If you are suc­cess­ful when the mar­ket says you are wrong, it can cre­ate a sense of hubris. It can leave you over­con­fi­dent in your own opin­ions and can set you up for a big fall. And that is what hap­pened.”

High ex­pec­ta­tions

It is free-lunch Fri­day at Se­quoia, and this re­porter is stunned at the view as I en­ter the 50th-floor of­fices where the Se­quoia Fund is head­quar­tered. The com­pany is en­sconced on the top floor of 9 W. 57th St., New York.

The Solow Build­ing, in­for­mally named for its owner, speaks money. Cur­rent and for­mer ten­ants in­clude the French fash­ion and fra­grance com­pany Chanel and pri­vate eq­uity firms Kohlberg Kravis Roberts and Apollo Global Man­age­ment.

I once asked a promi­nent real es­tate mogul in New York, “What is the most pres­ti­gious and valu­able piece of New York com­mer­cial real es­tate?”

Nine West 57th, he said with­out a mo­ment’s pause.

Its ar­chi­tect was one of the most promi­nent of the mid-20th cen­tury, Gor­don Bun­shaft of Skid­more, Owings and Mer­rill. Owner Shel­don Solow, a col­lege dropout and son of a brick­layer, rode this mar­ble-and-glass land­mark to a $4 bil­lion for­tune.

Ruane, Cun­niff can af­ford the of­fices. Its 1 per­cent an­nual fee on the com­bined $11 bil­lion that the firm man­ages cre­ates more than $100 mil­lion a year in rev­enue.

Over the years, the firm de­vel­oped an al­most cult­like, word-of­mouth fol­low­ing. It stopped tak­ing on new clients for many years so its as­sets did not be­come un­wieldy, which would make it dif­fi­cult to find com­pa­nies that could pos­i­tively af­fect re­sults. Fewer clients also meant fewer as­sets un­der man­age­ment. And fewer as­sets meant the 1 per­cent fee was col­lect­ing from a smaller pot, which in turn meant less in­come for the own­ers.

The founders didn’t care. “Bill and Rick had a strong con­vic­tion that they wanted to die hav­ing beaten the S&P 500 more than they wanted to die hav­ing max­i­mized our as­sets un­der man­age­ment,” Poppe said.

The $100 mil­lion cov­ers salaries for its 60 em­ploy­ees, in­clud­ing Wall Street salaries for its 20 an­a­lysts who travel widely re­search­ing com­pa­nies. There are le­gal ex­penses, trad­ing and reg­u­la­tory ex­penses, fees and ex­penses for the fund’s di­rec­tors. If there are prof­its af­ter ex­penses, they are paid in dis­tri­bu­tions to the Ruane, Cun­niff pri­vate own­ers, com­pris­ing em­ploy­ees and out­side share­hold­ers, in­clud­ing the Cun­niff fam­ily. There are more than a dozen share­hold­ers in all.

The firm nur­tures a fil­ial at­mos­phere with an al­most solemn de­vo­tion to the legacy of the founders and their value-based be­lief sys­tem. One keeper of the flame is Jonathan Brandt, the res­i­dent Berk­shire Hath­away an­a­lyst and 25-year em­ployee whose fa­ther worked at Ruane, Cun­niff. His fa­ther was an in­ti­mate of Buf­fett’s.

Ev­ery­one seems to have ten­ure. “I can only think of two peo­ple who have left over my 25 years here,” Brandt said. “They gen­er­ally don’t leave.”

Poppe, a for­mer jour­nal­ist with the Mi­ami Her­ald, has been at the firm 18 years. Har­ris, 15. For­mer Wall Street Jour­nal re­porter Greg Stein­metz, 17.

In the wake of the Valeant af­fair, the firm has over­hauled its stock-pick­ing process. Un­der the old sys­tem, Gold­farb, Poppe and one other ro­tat­ing an­a­lyst de­cided when to make an in­vest­ment and whether to end one. That has changed to a five-per­son in­vest­ment com­mit­tee re­quir­ing four votes to make a move.

“Four-to-one strikes us as a high hur­dle,” Poppe said. “Some­thing has got to be re­ally good, and there’s got to be great con­vic­tion be­fore we want to make that in­vest­ment.”

Were they ever wor­ried the firm was not go­ing to sur­vive Valeant?

Poppe paused a sec­ond. “I worry about ev­ery­thing,” he said, “but I didn’t ac­tu­ally worry that the firm was not go­ing to make it.”

Har­ris added, “Not for a sec­ond.”

Sev­eral mem­bers of the se­nior team have dou­bled down on Se­quoia by pur­chas­ing its shares. Most of them have vir­tu­ally their en­tire net worth tied up in the firm, through di­rect own­er­ship of shares in Ruane, Cun­niff or through own­er­ship of Se­quoia Fund shares.

Se­quoia is pros­per­ing, with year-to-date re­turns just shy of 10 per­cent. Morn­ingstar’s McDe­vitt said it could use a home run.

“This is a time where from an op­tics stand­point,” he said, “they want to be per­form­ing re­ally well.”

Poppe and his se­nior team said per­for­mance will go a long way to wash­ing away the Valeant stain.

“We have to do a great job for our clients,” Har­ris said. “Pretty much ev­ery­body at this firm came here be­cause they thought it was . . . one of the few beau­ti­ful cathe­drals to value in­vest­ing. And they wanted to live and work in­side it.

“If it’s got a lit­tle bit of dirt on it now, then we need to wipe it off and get back to do­ing what we’ve al­ways done.”


Ruane, Cun­niff & Gold­farb chief David Poppe, seated, with an­a­lyst Jonathan Brandt in June at the com­pany’s of­fices in New York. The firm’s long-suc­cess­ful Se­quoia Fund was built on the con­cept of value in­vest­ing — a con­cept be­ing tested in to­day’s mar­ket.


It was 1969 when Wil­liam J. Ruane and Rick Cun­niff founded a stock-pick­ing firm that be­came known as Ruane, Cun­niff & Gold­farb. A year later, they cre­ated their flag­ship mu­tual fund, Se­quoia. The fund grew with the help of Ruane’s friend War­ren Buf­fett, who rec­om­mended it to in­vestors. Buf­fett’s Berk­shire Hath­away re­mains a core hold­ing, rep­re­sent­ing 11 per­cent of Se­quoia’s as­sets.

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