The firm Ruane, Cunniff, & Goldfarb was founded in 1969 by the late William Ruane and Richard Cunniff to provide financial advisory services to individuals and institutions. Ruane enjoyed a friendship with Warren Buffet since they studied together under the founder of value investing Benjamin Graham at Columbia University. When Warren Buffet shut down his investment partnership in 1969 as he did not perceive too many undervalued opportunities in the markets, he recommended that all his clients who were interested in reinvesting their proceeds in the stock market go with Ruane as they shared the fundamental philosophy of value investing. To accommodate the clients, Ruane along with Cunniff (who is also a former student of Graham) established their flagship Sequoia Fund in July 1970 with an initial capital of 20 million dollars. Rather than a typical hedge fund partnership arrangement, the Sequoia Fund was structured as a domestic stock mutual fund charging a total of about 1% in fees.

As Buffet had “predicted” (it is never wise to second guess him!), after a decent performance in the first two years, the stock market lost almost 15% in 1973 followed by a loss of 26.5% in 1974 (most people who were old enough then, find the crisis today that began in 2008 as similar in depth and sentiment to 73-74 rather than the recession of early 2000s). The Sequoia Fund lost 25% (10% underperformance of S&P 500) in 1973 and 15% in 1974 (11% outperformance): the fund’s switch from the underperformance to the outperformance marked the start of the managers’ learning curve of applying the theory of value investing to the realities of the stock market.

Today the Sequoia Fund has assets of 3.5 billion dollars (and the firm Ruane, Cunniff, & Goldfarb advises close to 14 billion). Since inception, over the following next four decades, the fund has garnered an average annual return (net-of-fees) of 14% in contrast to the S&P 500 returning 10% for the same time period. In concrete numbers, while an investment of 10,000 dollars in the S&P 500 would have amounted to 525 thousand dollars, the same investment in the Sequoia Fund stands at an impressive 2.2 million dollars.

These returns, as is evident from the association and trusting relationship between the managers and Buffet, were founded on the most basic fundamentals of value investing as defined by Graham-Dodd and since espoused by many value investors. Sequoia formulates these principles as: (1) Buying companies with growth potential at a depressed valuation after rigorous fundamental number crunching (no technical analysis), (2) Treating the stock purchase as an ownership in the company rather than a trade, (3) Akin to how one would treat a company one owns, holding it for the very long term, and (4) Since one will only own companies that one understand intimately, having a very concentrated portfolio.

This “simple” value-biased (nay, value-only) philosophy served the fund well. Besides the above-mentioned turbulence in 73-74, they did not have any down years (with the exception of a 3.84% decline in 1990) until 1999. Of course, the internet bubble of 1999 was marked by irrational gains, specifically in the technology and financial sectors as represented in the NASDAQ, and generally with a spill-over into anything that was perceived as a growth stock within the S&P 500. While many recently-fangled value investors changed their tune to accommodate their investors’ grievances of “my neighbor is making more than me”, the managers at the Sequoia Fund firmly stood by their investment philosophy despite a 16.5% loss.

Indeed, in their 1999 annual letter to shareholders, they raised the question (rhetorically, it turns out) “Should we be doing something differently?” They answered in the negative, reiterating their tested value philosophy. (Ironically, yet understandably, a major portion of their losses were due to their outsized position in Berkshire Hathaway.)

In the same letter, they went on to mention that a significant number of their shareholders had expressed concern and frustration about their lack of investments in the technology sector, accusing them of “agnosticism” when it came to the benefits of technology. They flatly denied the accusation that they were incognizant of the benefits of technology, since they kept a keen eye on whether the companies they were invested in leveraged technology or not.

Understanding the motive behind that complaint (the markets in general and technology sector in particular were doing extraordinarily better than the fund in 1999) and the short-term context of it, they made two points, one gentle and the other acerbic.

First, they admonished the shareholders by quoting Graham’s chapter entitled “The New-Era Theory” (referring to the 1929 market movements), “The notion that the desirability of a common stock was entirely independent of its price seems incredibly absurd. Yet the new era theory led directly to this thesis … The results of such a doctrine could not fail to be tragic”.

Second, they quoted Bob Kirby in regards to the then new-new era: “Rule 1) Any stock that has tripled during the past 12 months is a serious purchase candidate; and Rule 2) Any stock that has been flat for the past month or two or – God forbid – has gone down, is immediately sold”.

Last, the conclusion was that although their time-tested philosophy was indeed out of favor with the conditions of the market, they were not about to abandon it. Of course, akin to many iron-clad value investors, their stance vindicated itself by a gain of about 28% in the following three years compared to a loss of over 40% in the S&P 500 (not to mention the far worse loss of NASDAQ and the decimation of most internet stocks).

Naturally, another deviation from their mostly up years was 2008 when they lost 27%, outperforming the S&P 500 by 1000 basis points. In their letter to shareholders that year, however, there are no reminders of the basics of value investing: One can surmise that their shareholders had learnt that while the value philosophy has short-term fluctuations, the long-term returns continue to compound well on a risk-adjusted basis. (Of course, the outperformance did not hurt either.)

Nevertheless, the lessons of 2008 were not lost on the fund managers. In their most recent (2010) annual letter, they emphasized how they had diversified their portfolio to 37 positions (the most ever held by the fund). While this was partially attributable to the fact that they now have more analysts and thereby can follow more companies as if they own them, the volatility of a portfolio of less than 20 stocks in the recent whipsaw markets clearly contributed to this decision.

Accordingly, they reduced their huge position in Berkshire Hathaway from 30% to 10%. While their long-standing relationship with this stock was indeed a nod to Buffet’s investment prowess, it is noteworthy that they quote Buffet’s statement on how Berkshire will grow slower by virtue of its size to justify the reduction. (To avoid this issue of magnitude, the fund had closed its doors to new investors in 1982, only to reopen 26 years later in 2008.) So even the selling of Buffet’s shares was a homage to him: To quote their words, “When Warren Buffett tells the public that Berkshire’s growth rate will slow in the future, it behooves one to listen.” Tellingly, the proceeds were still in cash.

Managers’ Backgrounds:

Twenty days short of turning 80, William Ruane passed away on October 4, 2003 in New York City. He was a native of Chicago and earned a Bachelor’s degree in Electrical Engineering from University of Minnesota in 1945. Right after his graduation he joined the Navy but his plan to go to Japan was cut short as World War II ended. Next, he joined GE as an engineer but did not relish the work, so he enrolled in Harvard Business School and discovered his passion for investing. For the following 20 years he worked at the financial services firm Kidder Peabody and then famously founded his investment firm and its flagship Sequoia Fund along with Richard Cunniff.

Robert Goldfarb is the current President of Ruane, Cunniff, & Goldfarb and a co-manager of the Sequoia Fund. His last name was added to the firm when he became President in 2004. He joined the firm in 1971 right after earning his MBA from Harvard Business School. Previous to that he worked as a Portfolio Manager at Scudder, Stevens and Clark, after graduating from Yale University in 1967. In 2010, along with his co-manager of 11 years David Poppe, he was named the top fund manager of the year by Morningstar.

QUOTES

“Graham said, ‘Look at the company as a whole, not as a piece of paper. Then do a highly critical financial analysis.’ You don’t need inside information. Don’t need charts and mumbojumbo. It isn’t about momentum. It isn’t that guff the talking heads give you on CNBC.”

“Over time, a well selected portfolio should outperform the index.”

“We’re really one-balance-sheet-at-a time, one-company-at-a-time kind of investors. We don’t spend a lot of time on macro.”

“I have always thought of myself as a meek little lamb who is afraid of being fleeced.”

“If you want to outperform the market, you have to have a point of view and you have to concentrate on things that you know well and like.”

“What are they doing? Shifting money back and forth without creating value. Most mergers don’t work, but Wall Street trumps them up, and the CEO agrees because he wants to run a bigger operation. And some of those wrap accounts are terrible for clients-fees on fees.”

“Staying small is simply good business. It wouldn’t be fair to our customers if we had to spread our ideas too thin. There aren’t that many great companies.”