One of the best interviews with the Kahn brothers was with the Ivey Value Investing Class in 2005 and there’s one part in particular that encapsulates the mindset required to be a successful value investor. Here’s an excerpt from that interview:
25.57 The only thing I can say is we maintain a really strict contrarian approach. So if something is very popular and everybody loves it and we’re buying it we have to say to ourselves what are we doing wrong here. Because I’d say half of the price of a common stock is ‘fashion’ basically so what we’re doing is we’re buying long skirts at the thrift shop when mini skirts are in favor. So we’re buying the long skirts for a dollar or two and then waiting till long skirts come back into Saks and if you can do that you’re halfway home you know you’re almost halfway home if you can just stick to being a contrarian.
The fabled fund, known for its intense secrecy, has produced about $55 billion in profit over the last 28 years, according to data compiled by Bloomberg, making it about $10 billion more profitable than funds run by billionaires Ray Dalio and George Soros. What’s more, it did so in a shorter time and with fewer assets under management. The fund almost never loses money. Its biggest drawdown in one five-year period was half a percent.
Hedge funds that have relied on people to make bets are hiring quants like never before in search of answers to lackluster returns. They’re playing catch-up to firms such as Renaissance Technologies and Two Sigma Investments, among the leaders in using complex mathematical models for investing.
If a mutual fund or ETF holds securities that have appreciated in value, and sells them for any reason, they will create a capital gain. However, due to the structural differences in the way the shares are created, an ETF fund can avoid recognizing capital gains on trading profits because they can avoid the outright selling of holdings triggering a capital gain that would have to be distributed.
Mutual funds and ETFs risk generating tax bills for investors whenever they sell stocks in a fund’s portfolio at a profit. Investors can be liable for taxes on those capital gains even though they themselves don’t sell their fund shares. Mutual funds are required to pass on capital gains taxes to investors through the life of the investment, but ETFs incur capital gains only upon sales of the ETF.
When an ETF experiences redemptions, it can hand over a basket of the fund’s underlying securities instead of cash. It can also pick which shares to hand over, picking the shares with the highest cost basis will reduce the greatest embedded capital gains. Because the trade is conducted in-kind, no capital gains are realized. Although, ETFs don’t shield dividend and interest income from current taxation.
From the perspective of the Internal Revenue Service, the tax treatment of ETFs and mutual funds are the same. Both are subject to capital gains tax and taxation of dividend income. However, ETFs are structured in such a manner that taxes are minimized for the holder of the ETF and the timing on the ultimate tax bill, after the ETF is sold and capital gains tax is incurred, is left up to the the investor.
“It is easy to confuse day-to-day noise with actual and significant signals. If you are merely reacting to the latest market action, then what you have is not a plan — you have an instinctual, fear-driven reaction, and it’s the makings of a disaster.”
Our new leadership elected to sell our position in Valeant Pharmaceuticals, exiting completely by mid-June. Valeant was our largest position to start the year and its 80% decline through June 30 badly penalized our results. – Sequoia Fund Shareholder Letter
Sequoia Fund management’s decision to finally exit their stake in Valeant Pharmaceuticals ends a painful almost year long slide in their biggest position and what was at one time their best performing holding.
Sequoia was an early investor in the Mike Pearson era Valeant. A strong believer in what they saw as a savvy manager who took a value approach to buying healthcare assets and wringing efficiency from them. Sequoia started purchasing Valeant in early 2010, probably at prices in the mid teens, and by the end of the year the position accounted for 10% of the funds assets. At year end they already had a gain of 78%. A fantastic return on investment in less than one year and a big boost to the fund’s performance.
The fund managers continued to build a position over the next five years and were enjoying the outperformance the stock added to the fund’s returns. By 2015 the position reached 20% of the fund’s assets and Sequoia also became Valeant’s single largest shareholder.
Then in August of 2015 the position began to lose money. You can’t fault the fund managers for sitting on the position while the stock declined in August along with the rest of the global markets. Continue reading
Barry Ritholtz haas a great piece on Bloomberg.com about how active management is failing to keep up, much less beat passive management. I’ve often wondered having spent about 20 years trying to produce as much alpha as possible in a short amount of time (AKA trading) if there is less alpha to be created now that everyone has instantaneous access to the same information.
There was a time when having a Bloomberg terminal presented opportunities to make very easy profits just by receiving news before other traders, but since Regulation FD and Yahoo Finance those opportunities no longer exist.
Internet has leveled the playing field: How much information that once was the province of a select few is now in the hands of all?It was a huge game-changer when Yahoo message boards begin to fill up with posts from people doing legwork on individual companies. When someone reported that XYZ Tech’s employee parking lots were filled with cars 24/7 — including weekends — anyone paying attention understood that business was booming and that sales were going to beat investor expectations. For the few who grasped that, this was a period of large trading profits.This advantage exists only when a small number of people know what a large number of people are going to find out too late to act on. When everyone knows, the advantage disappears.
For his take on the reasons why active money management is failing to beat their benchmarks follow the link.
The holders of the Sequoia Fund are adding insult to injury. The large Valeant Pharmaceuticals position held by the fund can’t be liquidated in an orderly manner so the fund holders who would like to exit are receiving shares of other holdings instead of cash.
Valeant Pharmaceuticals has gone from darling to pariah in less than a year. They’ve finally jettisoned the CEO, but are now facing off with bondholders over a technical default for not filing timely financials.
Investors can learn a great deal from the lesson. Financial engineering, serial acquisitions, and an aggressive management leads to disaster. Throw in a healthy dose of debt to pay for the growth and you have a powder keg ready to explode at the first sign of downturn.
If you’re even a slightly above average investor who spends less than they earn, over a lifetime you cannot help but get rich, if you are patient.