large position sizes
At the end of June 2015, the Sequoia Fund had assets of $8.7 billion, of which 28.7% was in shares of Valeant Pharmaceuticals (VRX) and another 10.6% in Berkshire Hathaway.
How did these positions get so large?
a. The portfolio managers chose to have nearly 40% of their fund in two names. In fact, as VRX began to decline in the second half of last year, the managers bought more.
Don’t ask me why. To my mind, following Bernard Baruch’s dictum to have all one’s eggs in one basket may have been ok for the renowned speculator way back when, but it makes no business or economic sense for mutual funds today. According to the Wall Street Journal, two members of the board of directors of the fund resigned last year because they disagreed so strongly with the strategy.
b. SEC diversification rules permit this. The pertinent regulation has two parts:
- The fund can’t make a purchase of a security if doing so would make its total holding in the security more than 5.0% of fund assets. At the 5% threshold, the manager can allow the existing position to grow; he just can’t buy more. Growth can come because the security is outperforming and/or because the total asset size is shrinking.
- 25% of the fund’s assets are exempt from rule 1.
The second provision is much less well-known than the first. I’m not sure why the SEC wrote the rules the way it did (my guess would be lobbying from the fund management industry), but I can’t recall an instance where having a whopping position like Sequoia has with VRX didn’t end in tears. And I can only recall two other cases, one involving a junk bond fund, another a Pacific Basin fund, where managers took such large bets with shareholder money.