VRX - Valeant Pharmaceuticals International Inc.

[Haasje]

http://www.ft.com/cms/s/0/0fa7d92a-f149-11e5-9f20-c3a047354386.html

 

See last sentence of the article. Sequoia indirectly blaming the Valeant fiasco on junior team members of Sequoia. Such BS...

 

I remember vividly Sequoia Q&A calls with LPs where it was the senior Sequoia people who jumped in to defend their Valeant pick. The junior Sequoia analyst guy was far more self-effacing.

 

Sequoia's credibility is shot and done.

 

That's one way to read it and I agree it is at odds with prior communications. Another way is that senior analysts get more say in the process at expense of a (dictator?) portfolio manager.

 

[Guest Grey512]

Good point.

[fareastwarriors]

How Allergan Rose and Valeant Fell

 

http://www.bloomberg.com/gadfly/articles/2016-03-24/allergan-and-valeant-similar-starts-different-outcomes

[dorsiacapital]

Im not sure if posting my old comments in this thread are meant to discredit me? They seem pretty tame. I generally try to stick with facts and I dont see too much inaccurate there.

 

And Im points above were meant to help you think through the delayed 10-k. On some of your pts, you know that when scoping an audit you place reliance on the clients internal controls, which in part determines your sample size and materiality thresholds? If you have information that contradicts your initial reliance, you have to rescope the work, increase the sample size, and audit more.

 

Also, this company probably got put on their "at risk" client list, which means more auditing.

 

Sure, my response was totally childish. I just thought saying my comment didn't make "any sense" was a bit rich considering your prior attempts at prognostication. But neither of us have earned super forecaster status.

 

And again, you're ignoring my point that it is difficult (albeit not impossible) to believe both 1) Valeant is delaying the 10k because internal controls have broken down, and 2) the eventual 10k will only involve the Philidor revenue restatement. Yes, you can square that by saying internal controls have broken down BUT turns out things were fine except for this revenue issue despite the lack of internal controls (and senior leadership setting unrealistic performance expectations).  And if that proposition seems logical, then you should buy more.

 

[jay21]

Im not sure if posting my old comments in this thread are meant to discredit me? They seem pretty tame. I generally try to stick with facts and I dont see too much inaccurate there.

 

And Im points above were meant to help you think through the delayed 10-k. On some of your pts, you know that when scoping an audit you place reliance on the clients internal controls, which in part determines your sample size and materiality thresholds? If you have information that contradicts your initial reliance, you have to rescope the work, increase the sample size, and audit more.

 

Also, this company probably got put on their "at risk" client list, which means more auditing.

 

Sure, my response was totally childish. I just thought saying my comment didn't make "any sense" was a bit rich considering your prior attempts at prognostication. But neither of us have earned super forecaster status.

 

And again, you're ignoring my point that it is difficult (albeit not impossible) to believe both 1) Valeant is delaying the 10k because internal controls have broken down, and 2) the eventual 10k will only involve the Philidor revenue restatement. Yes, you can square that by saying internal controls have broken down BUT turns out things were fine except for this revenue issue despite the lack of internal controls (and senior leadership setting unrealistic performance expectations).  And if that proposition seems logical, then you should buy more.

 

Sorry - I tend to be blunt and to the point on forums / Twitter. Just more efficient communication; not trying to offend / belittle anyone.

 

I keyed in on the PwC would be finished with their audit by March 15. I am very familiar with auditing. That is not true. Typically auditors are still working the day before the company files (and on the day tbh). Whether or not that means there are more restatements, I have no idea and wasn't trying to guess. Just trying to provide more color on the audit process.

[mcmaaaaath]

http://www.ft.com/cms/s/0/0fa7d92a-f149-11e5-9f20-c3a047354386.html

 

See last sentence of the article. Sequoia indirectly blaming the Valeant fiasco on junior team members of Sequoia. Such BS...

 

I remember vividly Sequoia Q&A calls with LPs where it was the senior Sequoia people who jumped in to defend their Valeant pick. The junior Sequoia analyst guy was far more self-effacing.

 

Sequoia's credibility is shot and done.

 

 

You have it backwards--that last sentence is not them blaming the junior guys. It is them blaming the Portfolio Managers/ CEO. They are saying that those guys will now take more input from the analysts.

[VersaillesinNY]

I bumped into the following note regarding Robert Goldfarb:

 

“Bob is a brilliant investor who is singularly focused on his job, which also happens to be his passion. According to Jon [brandt], Bob lives three blocks from the office so that he can walk to work most days, including weekends, and never takes a vacation. As Yale’s chief investment officer David Swensen has said, great investors tend to have a screw loose (referring to their ability to put their investors’ interests ahead of their own), and Bob Goldfarb seems to fit the bill!” Investment News - Fall 2009

 

It must be devastating to leave the fund after so much dedication and commitment. After all, the firm added his name in 2004: Ruane, Cunniff and Goldfarb Inc.

I have great respect for the man and his past wisdom. As Buffett puts it: “It's good to learn from your mistakes. It's better to learn from other people's mistakes."

 

I recall that Sequoia’s fund used to have a 35% BRK position in 2004 and progressively reduced it in order to diversify its holdings.

According to the fund’s 2012 transcript, VRX was a 6 to 7% initial position; it grew to 32% of the fund in the summer of 2015 and it is now around 8% depending on the stock’s volatility.

The carnage came because of Goldbarb’s inability to take some profits. Shareholders felt wealthier during 5 years, only to see the fund melt within 7 months. If Sequoia had only kept their BRK oversized position instead, the outcome would have been different.

 

We miss Carol Loomis' insight, our best financial journalist and value investor's friend could write a great article on this Greek tragedy. From May 1971 until May 1973, John Loomis, Carol's husband also worked as a broker at Ruane, Cunniff & Stires Inc., it's Sequoia's fund was specifically created to take on Buffett partnership's smaller accounts. Remember, Gottesman at First Manhattan, didn't want the "small-fry" partners. Warren Buffett introduced Bob Golfarb to superinvestor Bill Ruane in 1971, extending the "value family" and building a network of "circles around circles of investing". Currently, Sequoia's losses are hurting National Indemnity employee's retirement plans and many others.

 

I see two scenarios for VRX, but I’m sure Cobf’s board and value investors "aficionados" sees plenty of them:

 

1/ VRX files its 10-K in early April, there are no more “cucarachas” in the accounting, it was just the CFO or the controller trying to get his 2014 bonus.

Confidence is restored, a new CEO comes on board, debt is progressively repaid, some assets are sold, the stocks shots back to a $ 100 range.

ValueAct, Sequoia, Pershing Square, Brave Warrior and other major funds downsize their positions; Bob Goldfarb and Mike Pearson rebuild their reputation and assets. Goldfarb rejoins the fund as an adviser, he live and breath value investing. A painful chapter gets closed but the saga continues. Pearson sues his former employer over forced ouster and seeks millions in damages.

 

2/ The Phoenix doesn’t arise from its ashes. VRX files its 10-K in late April an unveils more “cucarachas” in the books and managers misconduct, the stock plummets. The company is sold into pieces in order to repay creditors. Shareholder’s remaining value is wiped out. Bob Goldfarb acknowledges his mistake and multibillion dollars loss. The fund reopens to new investors and changes its name to Ruane, Cunniff & Alexander. Charlie Munger was right, he is always damn right! Bill Ackman impatiently moves to Singapore in order to start his third hedge fund, he names it Gotham Square.

 

As the oracle said: "This is like watching a good movie, and I don't know how it will end".

 

Movie disclaimer: All characters and events in this story are entirely fictional. Any resemblance to actual events or persons, is entirely coincidental.

 

[Liberty]

http://fortune.com/ackman-valeant-ceo-pearson-inside-story/

[Picasso]

Now that Valeant is looking to sell assets, it got me thinking. We finally get to see what these fabled IRR numbers look like with some concrete, real life "terminal values."

 

I'm getting giddy thinking where this thread goes when some of our number crunchers start calculating these 20% returns. Or lack thereof.

[Guest wellmont]

I bumped into the following note regarding Robert Goldfarb:

 

“Bob is a brilliant investor who is singularly focused on his job, which also happens to be his passion. According to Jon [brandt], Bob lives three blocks from the office so that he can walk to work most days, including weekends, and never takes a vacation. As Yale’s chief investment officer David Swensen has said, great investors tend to have a screw loose (referring to their ability to put their investors’ interests ahead of their own), and Bob Goldfarb seems to fit the bill!” Investment News - Fall 2009

 

It must be devastating to leave the fund after so much dedication and commitment. After all, the firm added his name in 2004: Ruane, Cunniff and Goldfarb Inc.

I have great respect for the man and his past wisdom. As Buffett puts it: “It's good to learn from your mistakes. It's better to learn from other people's mistakes."

 

I recall that Sequoia’s fund used to have a 35% BRK position in 2004 and progressively reduced it in order to diversify its holdings.

According to the fund’s 2012 transcript, VRX was a 6 to 7% initial position; it grew to 32% of the fund in the summer of 2015 and it is now around 8% depending on the stock’s volatility.

The carnage came because of Goldbarb’s inability to take some profits. Shareholders felt wealthier during 5 years, only to see the fund melt within 7 months. If Sequoia had only kept their BRK oversized position instead, the outcome would have been different.

 

We miss Carol Loomis' insight, our best financial journalist and value investor's friend could write a great article on this Greek tragedy. From May 1971 until May 1973, John Loomis, Carol's husband also worked as a broker at Ruane, Cunniff & Stires Inc., it's Sequoia's fund was specifically created to take on Buffett partnership's smaller accounts. Remember, Gottesman at First Manhattan, didn't want the "small-fry" partners. Warren Buffett introduced Bob Golfarb to superinvestor Bill Ruane in 1971, extending the "value family" and building a network of "circles around circles of investing". Currently, Sequoia's losses are hurting National Indemnity employee's retirement plans and many others.

 

I see two scenarios for VRX, but I’m sure Cobf’s board and value investors "aficionados" sees plenty of them:

 

1/ VRX files its 10-K in early April, there are no more “cucarachas” in the accounting, it was just the CFO or the controller trying to get his 2014 bonus.

Confidence is restored, a new CEO comes on board, debt is progressively repaid, some assets are sold, the stocks shots back to a $ 100 range.

ValueAct, Sequoia, Pershing Square, Brave Warrior and other major funds downsize their positions; Bob Goldfarb and Mike Pearson rebuild their reputation and assets. Goldfarb rejoins the fund as an adviser, he live and breath value investing. A painful chapter gets closed but the saga continues. Pearson sues his former employer over forced ouster and seeks millions in damages.

 

2/ The Phoenix doesn’t arise from its ashes. VRX files its 10-K in late April an unveils more “cucarachas” in the books and managers misconduct, the stock plummets. The company is sold into pieces in order to repay creditors. Shareholder’s remaining value is wiped out. Bob Goldfarb acknowledges his mistake and multibillion dollars loss. The fund reopens to new investors and changes its name to Ruane, Cunniff & Alexander. Charlie Munger was right, he is always damn right! Bill Ackman impatiently moves to Singapore in order to start his third hedge fund, he names it Gotham Square.

 

As the oracle said: "This is like watching a good movie, and I don't know how it will end".

 

Movie disclaimer: All characters and events in this story are entirely fictional. Any resemblance to actual events or persons, is entirely coincidental.

he is a brilliant investor who made a career ending mistake. a massive miscalculation that destroyed a lot of value for their old school shareholders who still don't know what hit them. since the vrx analyst also is leaving, my hunch is that rcg is busy exiting the vrx position, probably in it's entirety. nobody else at the firm believes in the company at this point. so much has changed. the vrx ceo, who was central to the long thesis is out. bg, the ex ceo of rcg who championed the vrx holding, will not return to the firm as a consultant imo, no matter what happens from this point. the damage is done.

[original mungerville]

Now that Valeant is looking to sell assets, it got me thinking. We finally get to see what these fabled IRR numbers look like with some concrete, real life "terminal values."

 

I'm getting giddy thinking where this thread goes when some of our number crunchers start calculating these 20% returns. Or lack thereof.

 

Let me take a stab: If Valeant indeed needs to liquidate to pay back debt, the "real life terminal values" of the businesses will, on average, be greater than the "zero" Hempton, feeling the need to masquerade as AZ Value, put on them - in the analysis he felt the need to twist in order to support his short case against a company he claimed was twisting their reported financials no less.

 

 

 

 

[VersaillesinNY]

Wellmont,

 

Remember, scenarios 1 & 2 are pure fiction :D .

 

Board,

 

As a disclosure, I'm trying to establish the lessons learned from this tragedy. This is not a critic towards Sequoia's remaining managers, analysts or shareholders.

 

It's too early because the story is still unfolding, but it will turn into an investment case study at some point that could perhaps be written by one of the two renowned journalists and current Sequoia team members.

 

There is a tendency to think that Goldfarb only made one large mistake. However, if and only if VRX doesn't recover and its thesis is 100% false, then Goldfarb & Co made several major mistakes:

 

1/ After 2004, the fund massively reduced its 35% position in a slow compounding machine: Berkshire Hathaway (+139.5% since 01/01/2005 until today).

 

2/ The fund paid important capital gains to Uncle Sam since it was an early BRK investor.

 

3/ The fund was unable to book a single profit in VRX during a five-year period.

 

4/ The fund had a position sizing problem:

    - the 2011, 7% initial position in VRX was already too big

    - the August 2015, 32% VRX grown position and concentration in a single sector (Healthcare) became controversial, risky and dangerous for a mutual fund.

 

For Sequoia's shareholders, it was like exchanging a concentrated piece of BRK (a compounder & diversified conglomerate) for a piece of VRX (a concentrated growth healthcare machine).

 

At least, Sequoia instinctively kept 15.3% of the fund in cash equivalent on June 30, 2015; it served as a buffer for past & current shareholder's redemptions, while protecting remaining shareholders.

 

Now, talking about crisis management, the fund is facing serious monthly withdrawals and several lawsuits.

Over 40 years, they've build one of the best value shareholders base in the world, so did BRK. But investors hate the feeling of growing rich and then give back a piece of the fortune, it's too painful.

 

I believe there is still lots of talent, experience and lessons learned left at Sequoia. If they reopen the fund to new and brave investors, they will be able to raise fresh money, stabilize the outflows and transition their team.

[shalab]

Here is an article about valueact:

 

http://www.nytimes.com/2016/03/29/business/dealbook/valueact-pays-a-price-for-its-supporting-role-at-valeant.html?_r=0

 

 

Wellmont,

 

Remember, scenarios 1 & 2 are pure fiction :D .

 

Board,

 

As a disclosure, I'm trying to establish the lessons learned from this tragedy. This is not a critic towards Sequoia's remaining managers, analysts or shareholders.

 

It's too early because the story is still unfolding, but it will turn into an investment case study at some point that could perhaps be written by one of the two renowned journalists and current Sequoia team members.

 

There is a tendency to think that Goldfarb only made one large mistake. However, if and only if VRX doesn't recover and its thesis is 100% false, then Goldfarb & Co made several major mistakes:

 

1/ After 2004, the fund massively reduced its 35% position in a slow compounding machine: Berkshire Hathaway (+139.5% since 01/01/2005 until today).

 

2/ The fund paid important capital gains to Uncle Sam since it was an early BRK investor.

 

3/ The fund was unable to book a single profit in VRX during a five-year period.

 

4/ The fund had a position sizing problem:

    - the 2011, 7% initial position in VRX was already too big

    - the August 2015, 32% VRX grown position and concentration in a single sector (Healthcare) became controversial, risky and dangerous for a mutual fund.

 

For Sequoia's shareholders, it was like exchanging a concentrated piece of BRK (a compounder & diversified conglomerate) for a piece of VRX (a concentrated growth healthcare machine).

 

At least, Sequoia instinctively kept 15.3% of the fund in cash equivalent on June 30, 2015; it served as a buffer for past & current shareholder's redemptions, while protecting remaining shareholders.

 

Now, talking about crisis management, the fund is facing serious monthly withdrawals and several lawsuits.

Over 40 years, they've build one of the best value shareholders base in the world, so did BRK. But investors hate the feeling of growing rich and then give back a piece of the fortune, it's too painful.

 

I believe there is still lots of talent, experience and lessons learned left at Sequoia. If they reopen the fund to new and brave investors, they will be able to raise fresh money, stabilize the outflows and transition their team.

[fareastwarriors]

ValueAct Pays a Price for Its Supporting Role at Valeant

 

http://www.nytimes.com/2016/03/29/business/dealbook/valueact-pays-a-price-for-its-supporting-role-at-valeant.html?_r=0

[Guest wellmont]

i don't think reducing the size of brk at that time was a problem or a wrong move. they explained it at the time of the decision. they know that company exceedingly well and had determined that it no longer was a compelling value at the price, and not worth a 35% allocation. they had identified a number of opportunities that they believed could add value at a faster clip than Berkshire.

 

as for the mistakes made over the years, they can be traced to the two members of the team who just left. But the buck stops with the intransigent CEO who was the real champion and cheerleader here. He was so wedded to his idea that he could not take any chips off the table after massive gains brought the stock to nose bleed valuations.

 

I am surprised they haven't opened the fund. Perhaps it's not the right time and would smack of desperation. I suspect the fund will reopen. the silver lining is the fund will likely stabilize around the $4b asset mark. that will be a good size fund for this team and will allow them to own smaller more dynamic companies.

 

With all the lessons learned and the changes made, I still believe you can't do much better than these guys if you are looking to put money away for the long haul in an equity mutual fund.

[dorsiacapital]

i don't think reducing the size of brk at that time was a problem or a wrong move. they explained it at the time of the decision. they know that company exceedingly well and had determined that it no longer was a compelling value at the price, and not worth a 35% allocation. they had identified a number of opportunities that they believed could add value at a faster clip than Berkshire.

 

as for the mistakes made over the years, they can be traced to the two members of the team who just left. But the buck stops with the intransigent CEO who was the real champion and cheerleader here. He was so wedded to his idea that he could not take any chips off the table after massive gains brought the stock to nose bleed valuations.

 

I am surprised they haven't opened the fund. Perhaps it's not the right time and would smack of desperation. I suspect the fund will reopen. the silver lining is the fund will likely stabilize around the $4b asset mark. that will be a good size fund for this team and will allow them to own smaller more dynamic companies.

 

With all the lessons learned and the changes made, I still believe you can't do much better than these guys if you are looking to put money away for the long haul in an equity mutual fund.

 

I can believe it. Why should we believe that this new management, which contains neither Ruane nor Cundiff, would have some special skill in identifying the next Berkshire.  Their last pick was Valeant.  (Last 10 years - Sequoia has returned 14%, the S&P has returned 56%. If you add in management fees of 1% a year, they're basically flat for 10 years- http://bit.ly/1Y014jz).  They've also seen the  light now, but I think it was remarkably dysfunctional that two board of directors members resigned over the Valeant position and they still didn't trim/reduce their position. In fact, they added more. Sure, now they're doing something once the cow is out of the barn but so what.

 

If you want a value oriented mutual fund, I'd just buy Berkshire. No management fees and a probable discount to nav. Otherwise, follow Buffet's advice and buy an index fund or maybe a smart beta fund. 

[dorsiacapital]

Now that Valeant is looking to sell assets, it got me thinking. We finally get to see what these fabled IRR numbers look like with some concrete, real life "terminal values."

 

I'm getting giddy thinking where this thread goes when some of our number crunchers start calculating these 20% returns. Or lack thereof.

 

Let me take a stab: If Valeant indeed needs to liquidate to pay back debt, the "real life terminal values" of the businesses will, on average, be greater than the "zero" Hempton, feeling the need to masquerade as AZ Value, put on them - in the analysis he felt the need to twist in order to support his short case against a company he claimed was twisting their reported financials no less.

 

I'm sure right for assets like B&L but their biggest on the books asset is Salix and that's going to have a terminal value of basically 0 depending on your timeframe.

[dorsiacapital]

Im not sure if posting my old comments in this thread are meant to discredit me? They seem pretty tame. I generally try to stick with facts and I dont see too much inaccurate there.

 

And Im points above were meant to help you think through the delayed 10-k. On some of your pts, you know that when scoping an audit you place reliance on the clients internal controls, which in part determines your sample size and materiality thresholds? If you have information that contradicts your initial reliance, you have to rescope the work, increase the sample size, and audit more.

 

Also, this company probably got put on their "at risk" client list, which means more auditing.

 

Sure, my response was totally childish. I just thought saying my comment didn't make "any sense" was a bit rich considering your prior attempts at prognostication. But neither of us have earned super forecaster status.

 

And again, you're ignoring my point that it is difficult (albeit not impossible) to believe both 1) Valeant is delaying the 10k because internal controls have broken down, and 2) the eventual 10k will only involve the Philidor revenue restatement. Yes, you can square that by saying internal controls have broken down BUT turns out things were fine except for this revenue issue despite the lack of internal controls (and senior leadership setting unrealistic performance expectations).  And if that proposition seems logical, then you should buy more.

 

Sorry - I tend to be blunt and to the point on forums / Twitter. Just more efficient communication; not trying to offend / belittle anyone.

 

I keyed in on the PwC would be finished with their audit by March 15. I am very familiar with auditing. That is not true. Typically auditors are still working the day before the company files (and on the day tbh). Whether or not that means there are more restatements, I have no idea and wasn't trying to guess. Just trying to provide more color on the audit process.

 

In the interest of intellectual honesty, I will say recent news in Fortune and elsewhere about how the BoD is very reluctant to sign off on the 10k without the ad hoc committee finishing because they're worried about their own potential civil/criminal liability does seem like a very plausible explanation for the delay that does not raise a going concern issue.

[jay21]

You may want to look at SUNEs delays as well.

[rishig]

i don't think reducing the size of brk at that time was a problem or a wrong move. they explained it at the time of the decision. they know that company exceedingly well and had determined that it no longer was a compelling value at the price, and not worth a 35% allocation. they had identified a number of opportunities that they believed could add value at a faster clip than Berkshire.

 

as for the mistakes made over the years, they can be traced to the two members of the team who just left. But the buck stops with the intransigent CEO who was the real champion and cheerleader here. He was so wedded to his idea that he could not take any chips off the table after massive gains brought the stock to nose bleed valuations.

 

I am surprised they haven't opened the fund. Perhaps it's not the right time and would smack of desperation. I suspect the fund will reopen. the silver lining is the fund will likely stabilize around the $4b asset mark. that will be a good size fund for this team and will allow them to own smaller more dynamic companies.

 

With all the lessons learned and the changes made, I still believe you can't do much better than these guys if you are looking to put money away for the long haul in an equity mutual fund.

 

I can believe it. Why should we believe that this new management, which contains neither Ruane nor Cundiff, would have some special skill in identifying the next Berkshire.  Their last pick was Valeant.  (Last 10 years - Sequoia has returned 14%, the S&P has returned 56%. If you add in management fees of 1% a year, they're basically flat for 10 years- http://bit.ly/1Y014jz).  They've also seen the  light now, but I think it was remarkably dysfunctional that two board of directors members resigned over the Valeant position and they still didn't trim/reduce their position. In fact, they added more. Sure, now they're doing something once the cow is out of the barn but so what.

 

If you want a value oriented mutual fund, I'd just buy Berkshire. No management fees and a probable discount to nav. Otherwise, follow Buffet's advice and buy an index fund or maybe a smart beta fund.

 

They had plenty of good picks other than Valeant. I have closely followed Sequoia (luckily no Valeant - I never understood it) and often found very good ideas from their portfolio - TJX (522% over 10 years), MA (2000% over 10 years),  ORLY (666% over 10 years). I owned TJX for nearly 8 years, and I have owned MA for about 6 years. I owned PCP in the past and learnt about PCP from their annual letters (way before the BRK acquisition). I owned Mohawk (again learnt about it from their portfolio) as a way to bet on the housing recovery.

 

I think their biggest error was of portfolio sizing - they sized Valeant too big and the rest of the other stocks too small. My guess is that Goldfarb was probably idolized within the firm and his opinion mattered more than anyone else. I also found it amusing that Goldfarb put a lot of trust in Rory Priday's (the analyst covering Valeant) judgement. The fellow had just graduated from Harvard undergrad in 2010.

 

Now, that he is gone, they probably will have a more balanced portfolio (i.e. concentrated in 10-15 stocks but equal sized positions). It's difficult to avoid mistakes, but it's worse when your portfolio is so heavily skewed towards 1-2 stocks that you may have winners in the rest of your portfolio, it wouldn't matter. Picking 3 stocks for your portfolio is not for mere mortals like us. Best to leave that kind of concentration to Munger.

 

I think the biggest danger from here out is that good analysts within the firm are probably very shaken up. Career risk will always be on the top of their minds and they may never want to stick their neck out. I think running a concentrated portfolio of equal sized positions with contrarian bets is best suited for individual investors that are enterprising (Ben Graham's definition) or for managers with permanent capital.

 

 

[coc]

I can believe it. Why should we believe that this new management, which contains neither Ruane nor Cundiff, would have some special skill in identifying the next Berkshire.  Their last pick was Valeant.  (Last 10 years - Sequoia has returned 14%, the S&P has returned 56%. If you add in management fees of 1% a year, they're basically flat for 10 years- http://bit.ly/1Y014jz).

 

This attribution of their performance isn't accurate because it doesn't include distributions they've made. See the chart in here for a more accurate look -- just adjust for losses since end of 2015.

 

http://www.sequoiafund.com/Reports/Annual/Ann15.htm

[coc]

It's difficult to avoid mistakes, but it's worse when your portfolio is so heavily skewed towards 1-2 stocks that you may have winners in the rest of your portfolio, it wouldn't matter. Picking 3 stocks for your portfolio is not for mere mortals like us. Best to leave that kind of concentration to Munger.

 

I think running a concentrated portfolio of equal sized positions with contrarian bets is best suited for individual investors that are enterprising (Ben Graham's definition) or for managers with permanent capital.

 

One comment I'd make on this is that it heavily, heavily depends on what you own. I never hear about this. If your three stocks are Mastercard, Union Pacific, and Berkshire, are you at risk for some horrible worldly outcome?

 

On the other hand, if your three stocks are Twitter, Tesla, and Herbalife, I'm not sure the concentrated life is for you.

 

In my opinion, there's a lot more to it than "How many stocks?" Well...which ones? Valeant was a poor choice for a 1/3 weighting because it was enormously leveraged, used very aggressive accounting, and had an increasingly aggressive business model to back it up, led by some extremely aggressive incentive plans. The risk inherent in Berkshire or CSX or Procter & Gamble is so far less...

 

I think where the concentration idea gets into trouble is when the P&G's of the world are not offering you the returns you desire. That's my theory of what happened with Sequoia. They didn't think they could get the returns they were used to in low-risk business models, so they were seduced into sizing up a very aggressive one. If they had simply bought more TJX or Mastercard, or O'Reilly, or any number of lower-risk businesses in their portfolio, we'd never have had this discussion. It's really fascinating.

[rishig]

It's difficult to avoid mistakes, but it's worse when your portfolio is so heavily skewed towards 1-2 stocks that you may have winners in the rest of your portfolio, it wouldn't matter. Picking 3 stocks for your portfolio is not for mere mortals like us. Best to leave that kind of concentration to Munger.

 

I think running a concentrated portfolio of equal sized positions with contrarian bets is best suited for individual investors that are enterprising (Ben Graham's definition) or for managers with permanent capital.

 

One comment I'd make on this is that it heavily, heavily depends on what you own. I never hear about this. If your three stocks are Mastercard, Union Pacific, and Berkshire, are you at risk for some horrible worldly outcome?

 

On the other hand, if your three stocks are Twitter, Tesla, and Herbalife, I'm not sure the concentrated life is for you.

 

In my opinion, there's a lot more to it than "How many stocks?" Well...which ones? Valeant was a poor choice for a 1/3 weighting because it was enormously leveraged, used very aggressive accounting, and had an increasingly aggressive business model to back it up, led by some extremely aggressive incentive plans. The risk inherent in Berkshire or CSX or Procter & Gamble is so far less...

 

I think where the concentration idea gets into trouble is when the P&G's of the world are not offering you the returns you desire. That's my theory of what happened with Sequoia. They didn't think they could get the returns they were used to in low-risk business models, so they were seduced into sizing up a very aggressive one. If they had simply bought more TJX or Mastercard, or O'Reilly, or any number of lower-risk businesses in their portfolio, we'd never have had this discussion. It's really fascinating.

 

May be it's just hard to say what is "lower-risk" in foresight. Better to just use prudence and not get overly concentrated. I have heard Pabrai / Spier say that they would not buy bigger than 10% position but would let the stock run up and be 30%-40% of the portfolio. I think the danger with such a portfolio philosophy is the same. It works 9 out of 10 times, but the one time it blows up, it destroys 10 years of compounding.

[Haasje]

The vast majority of the time;  concentration isn't taken far enough. Most managers are acutely aware of the career risk and diversify way too much. Read the articles on how active share has moved over time, its ridiculous. The asset management industry has an enormous principal-agent problem.

 

But avoiding the career risk really does make sense. That's why its so hard to watch whats happening to Bob Goldfarb, Bill Ackman etc. With hindsight we all know they could have avoided this trainwreck. But is it really in the best interest of clients? If we all work really hard to avoid getting fired at the expense of generating alpha?

 

I admire the guys with the guts and who are building the culture to be able to make these concentrated bets.

 

Having said that, limiting yourself to an initial 10% and then letting it run up to 40% doesn't sound that good. Mainly because I have a hard time believing while its running up that much (assuming you are not getting trashed by everything else) its expected value > your other investments is really increasing by a magnitude that would justify that allocation. It could be good, if your source of Alpha is some kind of momentum strategy but its usually not accompanied by a claim like that.

 

[coc]

It's difficult to avoid mistakes, but it's worse when your portfolio is so heavily skewed towards 1-2 stocks that you may have winners in the rest of your portfolio, it wouldn't matter. Picking 3 stocks for your portfolio is not for mere mortals like us. Best to leave that kind of concentration to Munger.

 

I think running a concentrated portfolio of equal sized positions with contrarian bets is best suited for individual investors that are enterprising (Ben Graham's definition) or for managers with permanent capital.

 

One comment I'd make on this is that it heavily, heavily depends on what you own. I never hear about this. If your three stocks are Mastercard, Union Pacific, and Berkshire, are you at risk for some horrible worldly outcome?

 

On the other hand, if your three stocks are Twitter, Tesla, and Herbalife, I'm not sure the concentrated life is for you.

 

In my opinion, there's a lot more to it than "How many stocks?" Well...which ones? Valeant was a poor choice for a 1/3 weighting because it was enormously leveraged, used very aggressive accounting, and had an increasingly aggressive business model to back it up, led by some extremely aggressive incentive plans. The risk inherent in Berkshire or CSX or Procter & Gamble is so far less...

 

I think where the concentration idea gets into trouble is when the P&G's of the world are not offering you the returns you desire. That's my theory of what happened with Sequoia. They didn't think they could get the returns they were used to in low-risk business models, so they were seduced into sizing up a very aggressive one. If they had simply bought more TJX or Mastercard, or O'Reilly, or any number of lower-risk businesses in their portfolio, we'd never have had this discussion. It's really fascinating.

 

May be it's just hard to say what is "lower-risk" in foresight. Better to just use prudence and not get overly concentrated. I have heard Pabrai / Spier say that they would not buy bigger than 10% position but would let the stock run up and be 30%-40% of the portfolio. I think the danger with such a portfolio philosophy is the same. It works 9 out of 10 times, but the one time it blows up, it destroys 10 years of compounding.

 

I'm sorry but I do not agree -- the foresight thing is a cop-out. Does it take a genius to know that Valeant with $30 billion of debt, trading at an astronomical price compared to any non-gameable metric, is way higher risk than Berkshire Hathaway? By an order of magnitude? I had a conversation with some board member on this a few years ago when it was riding high and he couldn't see it. (I don't know if he held on, but I hope not.) Is it possible to know that Wal-Mart in 1997 and Pier One Imports in 1997 had very different risk levels even if their 10-yr figures probably looked the same?

 

If you can't make these differentiations, I don't know what to tell you...this might not be the right line of work. Buffett called it the "Hula-hoop company vs Barbie company" problem -- the numbers would look similar or even better for the HH company while it was hot, but a good analyst knows the difference. That's the essence of the process.

 

I respect Sequoia, Guy S., and Mohnish greatly, I do. But I simply do not think the stuff they loaded up on -- ZINC, FIAT, GM, VRX, and so on -- are the types of companies Buffett and Munger invest heavily in, or the things they have in mind as concentrated investment candidates. That's why Munger was so vocal about VRX, why he was so wishy-washy about Ted W. owning GM in size, and why Buffett made it clear he was quite surprised to see one of his guys investing in Kinder Morgan. (See CNBC transcript online.)

 

Concentration and conservative investments go hand in hand - you can't have one without the other. And if you can't tell, a priori, what a low-risk business looks like, I'm not sure you have any business actively managing money.

 

To be clear, if you're more comfortable with 20 stocks instead of 3, that's completely fine - I take no issue with it. That's worked well for some. But going from 20 to 3 is perfectly possible if you're smart about how you do it. I'm amazed at how everyone handwaves away one of the biggest parts of the Buffett/Munger philosophy.