“World’s Greatest Mutual Fund Re-opens — Could re-close any minute”

By Travis Johnson, Stock Gumshoe, June 18, 2008

This teaser email came in a week or so ago, from another Stansberry service, Extreme Value by Dan Ferris.

Here’s how they whet our appetite:

“In 17 days… The 19,900% Mutual Fund Could Close for Good…

“MSNBC says… “Get in line early for this fund.”

“It’s been called the “Holy Grail” of mutual funds…”

Nice, huh? If you’re like most people, even most individual stock owners, you still hold some mutual funds — and I do, too. There’s nothing wrong with having someone else manage your money, or a portion of your money, and a good mutual fund is by far the cheapest way to do that for most people (of course, a bad mutual fund can be disastrous and expensive, and a mediocre will slowly bleed your account with fees and turnover costs, but the good ones can be very good).

The mutual fund they’re teasing here has been closed to new investors for “almost three decades”, according to the ad, having closed the doors in the 1980s.

This one has been more desirable than many other closed funds in recent years — as they note in the teaser, “a few years back, one share was offered for sale on Ebay for almost 10x its market price.”

That’s just stupid, of course — it really happened, though the sale didn’t actually take place and the listing was removed because Ebay isn’t allowed to sell securities … and it was in the height of the stock market mania in 1999, so God knows what people were thinking.

They tease us a bit more with the performance of the fund in recent years …

“Over the past 5 years the fund is up over 73%… Since 1998 it’s returned almost double that amount… And for investors lucky enough to own shares for last two decades? Well, they’ve been rewarded with gains of over 1,253%…”

Not bad!

So Ferris says that “I recommend you buy The World’s Greatest Mutual Fund right away. I think it’s one of the safest, long-term investments around today… ”

Of course, in exchange for sending you his special report, entitled “The World’s Greates Mutual Fund,” Dan and his publishers at Stansberry & Associates would like you to try out the Extreme Value newsletter for $1,000.

The Gumshoe, of course, does not require that you send him $1,000 (though smaller contributions are more than welcome) — I’ll let you know the “secret” of this fund in just a moment.

The fund also has a Buffett connection …

“The World’s Greatest Mutual Fund was started over 38 years ago by one of Warren Buffet’s closest advisors.

“The story goes, back in 1969 when Buffet closed his first investment partnership, partners were given the choice of Berkshire Hathaway stock or cash.

“For those that chose the cash distribution, Buffet strongly encouraged them to invest in this fund. Investors who did have seen gains topping almost 20,000%.

“How exactly does The World’s Greatest Mutual Fund create such stellar returns?

“Simply put, they’ve perfected an investment strategy that uncovers the most profitable businesses in the world.

“And while I can’t reveal the full details of their strategy in this letter (in a moment I’ll tell you how you can learn more about it), you should know that right now in their portfolio is a mix of companies you could virtually buy and hold forever.”

So … what are we looking at here?

This is the Sequoia Fund (SEQUX)

And it really was started by a Warren Buffett confidant in the 1970s (one of his brokers, I think), and was long-managed by fellow students of the legendary value investor, Ben Graham. It has indeed been closed since the early 1980s — and for many years, the fact that it was closed made it almost impossibly desirable.

Sequoia does hold a significant chunk of Berkshire Hathaway stock, though I think they pared back a bit over the past year (Berkshire is still about 25% of the fund).

Sequoia is considered a legendary value fund, with a long term perspective and a management team that has been with the fund for a long time. Recent performance has not been dramatically great, but it has been solid, and the performance over the long term has indeed been stellar.

It is a concentrated fund, with about 70% of its assets in the top ten holdings (including that big Berkshire stake), and it holds very few stocks compared to almost any other fund (only 25 as of their last report). Minimum investment is $5,000 and the expense ratio is a fairly average 1% (though lower would be nice). Hidden costs of high turnover won’t bleed you dry with this one, since they trade relatively infrequently.

What you’re buying if you invest in Sequoia is a concentrated portfolio that tends toward value investing ideas, but the managers have in recent years been more wiling to add “growth” names (generally, that means companies that are valued as if they’re going to grow faster than the average company). They don’t trade much, and don’t often add or subtract holdings (this year, according to Morningstar, they’ve added Rolls Royce and Martin Marietta Materials to the fund).

Unfortunately for new investors, you’re also buying a big tax liability. This is not unlike investing in Berkshire Hathaway itself, which has massive unrealized capital gains on the books that will become taxable if Buffett ever sells any of the core holdings like Washington Post, Wells Fargo, or Coca Cola. Sequioa, according to the most recent report I’ve seen on their website, says that 46% of the net asset value of the fund is comprised of unrealized capital gains. Even if you didn’t enjoy the capital gains because you weren’t there to see your shares go up in value as the asset value increased, you will still, if you buy shares today, owe taxes on those gains if they sell holdings and incur taxable gains.

They’re not quick sellers, so I wouldn’t suggest that there’s a big chance that you’ll owe lots of taxes immediately — but the potential is there if they decide to sell any of their appreciated stocks.

And a look at the portfolio as of March 31 tells us why they’re probably opening the fund to new investors — the old investors are probably retiring (as is noted in the teaser), and they need the money. Performance has still been very good over the last four or five years, though perhaps it hasn’t been as spectacular as some long-time shareholders might have gotten used to.

The only way to get that cash to redeem shares for investors is by either raising new cash by selling more shares in the fund, or by selling their holdings. Most of the top 25 holdings were reduced, albeit not dramatically, in the last reporting period, probably to a large extent in order to fund shareholder redemptions. They’ve been losing cash on a net basis for many years, not surprising since they’ve been closed for so long, and now manage about 25% less money than they did ten years ago (the fund is fairly small, less than $4 billion under management before they reopened last month).

There’s nothing bad or sinful about reopening and accepting more investments, of course — lots of funds are reopening now because shareholders are aging, or they had a year or two of bad performance and more shareholders than usual are cashing in, or just because they see great opportunities and want to raise more cash to invest.

And I would never suggest that Sequoia is anything but a great fund for the long term — but it’s not going to be perfect for everyone, and it may not dramatically outperform the market in any given year, or in the short term, though it has very consistently done better than it’s peers over long periods. This investment is designed to be a steady winner, not unlike Berkshire Hathaway itself, so it may be worth a look if that’s what you want.

The tease says that they might close the doors again at any moment — any fund can do so, of course, but it seems unlikely that they would stay closed for 25+ years and then make the decision to open for just a few moments. If the cash really swarms in, I suppose it’s possible, but I don’t see any reason for you to fear that they’ll be closing in “17 days” — or that they’ll close without announcing that they are going to close (they aren’t obligated to announce this in advance, as far as I know, but most do).

I greatly respect the Sequoia managers, and I like the fact that they closed the doors when they ran out of effective ways to invest new money (this is always a good sign of ethical fund management), but calling this the “World’s Greatest Mutual Fund” is, of course, just an opinion. Performance over the last ten years has been very good, but not spectacular — I am, to be honest, a little surprised that with a relatively small portfolio and little pressure from new money or redemptions over the last ten years, that Sequoia hasn’t done better. Dodge and Cox Stock (DODGX), which is a fund I’ve held for a long time and is also closed and has a similar investment style of value-oriented, bottom-up stock picking, has significantly better ten-year returns (9%+ versus 6.5% annualized) while being saddled with a massively larger portfolio, and some other smallish superstar funds with very similar strategies, like Fairholme (FAIRX), have done remarkably better than that.

So … nothing wrong with investing in Sequoia — it’s a good fund, albeit one with a big “hidden” tax liability, but it’s not a “sure thing” even though it’s well managed and has a great reputation. Plenty of articles came out when they announced that they would reopen that intimated that it was respected but maybe not the best option for everyone — here’s one from Marketwatch — (one quote from the story: “Some observers worry that Sequoia could be like the classic restaurant that was so exclusive no one could get reservations; when the doors finally open to the masses, those eager customers find that the restaurant’s glory days are past.”)

On the flip side, Sequoia has lots of fans for a very good reason, and it remains an outperformer. They still get a lot of credit for sidestepping the worst of the market in 2000, and many people think it’s a comforting choice in a scary market that’s reopening at just the right time for skittish investors … your call.

I do remember reading a suggestion, probably ten years ago, that folks who were interested in Sequoia but couldn’t get in might get similar returns with a portfolio of half S&P Index fund, half Berkshire Hathaway stock … another interesting thought, not specifically that you want to do that (and I haven’t checked to see how that would have worked). You can also always monitor the fund and see what they buy and sell if you want to follow a similar buy and hold strategy on your own — they don’t buy and sell quickly, so the fact that you only get to see their holdings changes once a quarter might not mean you miss the boat on new stocks they acquire … and the fact that they only hold 25 stocks at the moment means it’s pretty easy to look into the companies they like.

Full disclosure: I do have money invested in Dodge and Cox Stock, and in an S&P Index fund, and I do hold shares of Berkshire Hathaway. I don’t own any other investment mentioned above.


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21 Comments on "“World’s Greatest Mutual Fund Re-opens — Could re-close any minute”"

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eric
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eric
June 18, 2008 11:41 am

Thanks for unmasking this Stansberry teaser. I know you’re not the Mutual Fund Gumshoe, but the info is appreciated, nevertheless, as I was wondering about the answer.

EYOUNG
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EYOUNG
June 18, 2008 11:59 am
Thanks for a well written, well explained treatise, GumShoe! I DO have one question-How can a person determine the “hidden tax liability” of a fund, before investing? As a small investor (VERY small!), I cannot afford to have all my money eaten in fees and taxes, especially when I was / am not there for the gains! Maybe I am missing something here, as far as taxes goes, but at my age (65), I need all the help I can get!, without paying through the nose for it – and full service brokerages you “pay by the hour”, so to… Read more »
KatCFP
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KatCFP
June 18, 2008 12:14 pm

Sounds like a good fund to buy in a retirement account…..

Doug
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Doug
June 18, 2008 12:24 pm

total crap on technicals, stay away! to think someone would have charged me money for that info!

DBlain
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DBlain
June 18, 2008 12:30 pm
As always a great post Gumshoe. Your knowledge of mutual funds is most appreciated. This fund is certainly for long-term investors (To maximize gains on SEQUX I would personally use a time line of 10 years or more. But it does hold the core principals of a solid fund – lower fee structure, long-term management that have holdings in their own fund, solid track record of success, etc. I personally would recommend a different fund for people looking for a long term investment. It is managed my Irwin A. Michael, who is sometimes referred to as the “Canadian Warren Buffett”.… Read more »
SageNot
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SageNot
June 18, 2008 12:55 pm

I’m a Ken Heebner fan, here’s one reason why:

http://finance.yahoo.com/q/ta?s=SEQUX&t=5y&l=on&z=m&q=l&p=&a=&c=CGMFX,DODGX,FAIRX

SEQUX has been a small loser over the last 5yrs., so leave it to Porter’s guys to see an opportunity to “buy low,” but who pays the Cap Gains Tax even though SEQUX has become a loser?

NOT ME, thank you!

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P.S. What technicals are you talking about Doug? Who’s charging you any money?

AtlantaExplorer
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AtlantaExplorer
June 18, 2008 1:25 pm

Thanks for an excellent analysis, as I had been wondering whether Sequoia was worth buying into. NOTE: The Dodge & Cox Stock fund (and its Balanced fund) both reopened this spring. See dodgeandcox.com.

Steve B
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June 18, 2008 2:41 pm

Gumshoe Rocks! Again.

Pete Ewing
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Pete Ewing
June 18, 2008 5:51 pm

To follow up on DBlain’s recommendation of ABC Fundamental Value there is a great web site written by Irwin Michaels detailing why he bought the companies in the fund and updating his commentary. An excellent view into the mind of a great value investor.

http://www.valueinvestigator.com/en/valuefavourites/

Woman with Portfolio
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June 18, 2008 5:57 pm
I hate to be the party pooper, but folks really need to look dispassionately at the performance of these well regarded funds. Really closely. Look at their performance charts over the past year, as well as five years and ten years. (Easy to do on the Google finance site and others.) Look at the holdings and how they performed. Dodge and Cox has been the gold standard of funds, and many, many money managers put their clients into both the Dodge and Cox Stock as well as the Dodge and Cox Balanced. I have close friends and family members who… Read more »
SageNot
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SageNot
June 18, 2008 6:35 pm

I think that I agree with that last sentence Woman w/Portfolio, & Ken Heebner is thriving in that rapid change environment so far.

Before Real Estate took the pipe, Heebner had one of the better RE funds around, he’s money in the bank in my eyes!

Diane Reinstadtler
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Diane Reinstadtler
June 18, 2008 7:56 pm

Wondering about Whiskey and Gunpowder’s claims of June 18th…The Great Oil Hoax regarding Saudi Arabia’s oil production. Have you seen it. I can foward, but need an e-mail. Thanks

Diane

Pat
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Pat
June 18, 2008 11:36 pm

I saw it. Let me know if you find out.

joe cruz
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joe cruz
June 19, 2008 1:11 am

Well from research i’ve done if the stocks you pick aren’t outperforming the stock market a good index fund is money in the bank. A 75 year average of beating the market with avg returns of about 11%.I’m a small investor and would like to know if anyone has good stock picks they’d like to share.

John Sloan
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June 19, 2008 2:24 pm
HI all Yes, I saw the Whiskey pitch about Great Oil Hoax – and I already subscribe to OI – the ‘hoax’ is that the Saudi stated oil reserve being lower than official is ‘secret’ that analysis has been out for a long time. OI itself has been pitching that for a very long time. For instance, also, read “Profit from the Peak” by Brian Hicks and Chris Nelder – the best comprehensive book I have seen on future energy industry. Not only Saudi but many governments are over stating their oil reserves. Practically all OPEC countries do it because… Read more »
destry
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destry
June 22, 2008 12:06 pm
Sequoia is a good fund. And yet, it’s returns over;In this instance, 30 years, are not isolated, or particularly unique…Keep in mind Fidelity’s Magellan Fund;Under Peter Lynch,returned well over 3000%, in a 10-year period of time…The sobering point is that of everyone who was ever in it… over 2/3rds lost money. The reason is that, due to its’ 1% sales charge,it became a trading vehicle. By contrast…I know too many retired oil people, who bought shares of Exxon, from their first day as a roustabout on a West Texas oil rig…And kept buying; Sometimes a share at a time, even… Read more »
Gravity Switch
Admin
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June 18, 2008 12:15 pm

Hi EYoung. Some funds give details about this, as Sequoia does on their website, but Morningstar is good about sharing the information in a standard way in their profiles of mutual funds (which is part of their free service, not the premium stuff that includes their analyst comments). You can see the tax analysis of Sequoia, for example, here: http://quicktake.morningstar.com/FundNet/Tax.aspx?Country=USA&Symbol=SEQUX

Gravity Switch
Admin
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June 18, 2008 12:18 pm

Good point, if you like the fund but are worried about the embedded capital gains — that would certainly help with the potential tax liability.

Gravity Switch
Admin
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June 18, 2008 12:53 pm

Interesting, that’s one I’ve never heard of. Thanks for the thoughtful comments.

Gravity Switch
Admin
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June 18, 2008 3:07 pm
Good one, Sage — Ken is on the cover of Fortune this month, he’s certainly hot as can be the last couple years with CGM Focus. This is a very different kind of fund, with much more trading than the other ones noted here, and like Sequoia and Fairholme it has very concentrated positions (thus the “focus”). CGM Focus also throws in the occasional really, really bad year to go along with all those years that are really good or (like last year) genuinely spectacular. Another excellent fund, very few, if any, are as good or better over the long… Read more »
Gravity Switch
Admin
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June 18, 2008 3:11 pm
Thanks, hadn’t noticed that DODGX was reopened. I also like their foreign fund (DODFX) and have some money there, but that has been a ridiculous grower — it was started less than ten years ago, I think, and is already one of the 20 or so biggest funds in the US. Dodge and Cox is different from most advisors, they have very big funds that are managed by committee, and they don’t differentiate much by breaking things up into smaller sectors or strategies (Stock, Foreign Stock, Balanced, and Income — that’s it), but, to be honest, half the reason that… Read more »
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