The fund is more diversified than in years past, but no less focused on quality and the long term.
Sequoia (SEQUX) has significantly diversified its portfolio over the past six years after David Poppe joined Bob Goldfarb as comanager in 2005. We've written about that before, but spreading the fund's branches hasn't weakened its trunk.
During that time, the number of stocks in the portfolio has nearly doubled to 34. In 2005, Berkshire Hathaway (BRK.A) and Progressive (PGR) absorbed about half the portfolio's equity assets. Today, Progressive is gone and Berkshire is down to about 10% of assets.
While the portfolio has certainly changed since 2005, the traits that Goldfarb and Poppe look for in companies are largely the same, although with a few small tweaks. They still prize companies with sustainable competitive advantages and talented management teams that are effective capital allocators.
Sustainable Competitive Advantage
A lot of managers say that they are looking for companies with competitive advantages, but few actually follow through completely. Sequoia is one of the few that does. It shows most clearly in the fund's sector weightings, where it has little exposure to commodity-type businesses, or those where it is very difficult to create or sustain a competitive advantage. Note that the fund has hardly any positions in basic materials, energy, communications, or utilities. Few companies in these sectors have strong brands or franchises that allow them to generate higher than average profit margins.
That has traditionally been true in technology as well, a sector that the fund had long avoided. But in recent years, the fund has added several technology stocks, most notably Google (GOOG) and IBM (IBM) in 2010. The team added Google because it views it as more of a marketing company than a technology one, although it also believes that Google has an insurmountable advantage in search technology. Microsoft (MSFT), on the other hand, a current darling of some value managers, has spent billions taking a run at it and has met with little success, at least in terms of actually making money.
In IBM's case, the competitive edge is perhaps less obvious, as it owes to the company's combined expertise in software, hardware, and services and because it offers enterprise solutions to big companies. More important to Sequoia, though, was an IBM trait that's rare to find in technology.
Especially in companies that generate a lot of cash flow, Goldfarb and Poppe pay close attention to how they allocate capital. Do they reinvest in profitable projects and promising research and development, or do they blow it by overpaying for questionable acquisitions? IBM spends billions a year on R&D, but this has ultimately paid off in consistently strong profitability. On the other hand, the team worries about Google, which could get distracted spending money on unrelated projects such as cars that drive themselves. Microsoft is another example of a company with ample free cash flow but that has struggled for years to spend it profitably.
This issue is also endemic in health care, particularly with the big pharmaceutical companies. These also tend to be favorites of value managers, but Goldfarb and Poppe generally avoid them. That's because Big Pharma has a horrible track record at turning billions in R&D spending into marketable treatments.
Sequoia does have about twice the S&P 500 Index's exposure to health care, but none of it is in traditional Big Pharma. Top-holding Valeant Pharmaceuticals (VRX) spends little on R&D. Instead, it buys mature or niche drugs that it can market through its ample distribution network.