I read in the Wall Street Journal over the weekend that the Sequoia Fund (assets of around $5 billion) was experiencing heavy redemptions during 1Q16 and met them for some shareholders “in kind.”

Sequoia:  a first glance

I don’t know Sequoia at all.  A quick check of its December 2015 annual report shows the fund had what I judge to be a very unusual portfolio structure.  At that time Valeant Pharmaceuticals (VRX) made up 20% of assets (down from an even more whopping 28%+ in June of last year); Berkshire Hathaway, classes A and B, comprised another 13%.  That’s a third of the fund in two names.  Very concentrated, in my view.

Unfortunately for holders, VRX fell by 60% during the second half of 2015–during which time Sequoia boosted its position from 11.2 million shares to 12.8 million–before losing 2/3 of its remaining value since this January 1st. Hence the Sequoia redemptions …and the retirement of the fund’s senior portfolio manager.

The Journal reports that, in accordance with long-term fund policy, redemptions of $250,000 or more are being met substantially in kind, meaning that the seller is being paid mostly through a transfer of stock held in the fund portfolio, rather than in cash.  The WSJ cites one customer who received about 5% of his money in cash, the rest in shares of O’Reilly Automotive (ORLY).  That would probably mean less than 1,000 shares of a stock that trades 750,000+ shares a day.  So no liquidity problems.  Commission on the sale, other than benighted souls who patronize traditional high-cost brokers, isn’t a big deal, either.

How is this possible?

According to the WSJ (I haven’t checked, but I presume it’s a boilerplate feature of the prospectus), Sequoia discloses the policy of redemption in kind in its regulatory and marketing materials.

my thoughts:

I don’t ever recall hearing about redemptions in kind for retail investment products   before, although I suspect the provision is contained in every mutual fund and ETF prospectus.  The words “in kind” may not be there, but a general description of emergency measures likely is.

“In kind” strikes me as a draconian measure.  It certainly discourages/punishes redemptions.  And it’s not the sort of thing that encourages a customer to return at a later date.

It probably minimizes downward pressure on portfolio holdings from what would otherwise be forced selling by the fund.

It deals with tax issues in a way that doesn’t harm the redeeming customer and favors remaining shareholders.

How did the VRX position get so large?

More tomorrow.