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Poppe: We're Comfortable With Concentration

Kevin McDevitt, CFA

Kevin McDevitt: Hi, I'm Kevin McDevitt, Morningstar fund analyst, and we are here at the Morningstar Conference with David Poppe from the Sequoia Fund. David, thank you for joining us.

David Poppe: Thank you.

McDevitt: So, I wanted to talk to you about some aspects of your portfolio, and one of the things in looking at your portfolio, it seems like there are not that many capital-intensive businesses, and knowing your long association with Warren Buffett and how he has kind of changed his tune to some extent in recent years about capital-intensive businesses, I'm curious how your thinking has evolved and if in any way you are more open or if there are any types of capital-intensive businesses that you might like?

Poppe: I can't speak for him, but I think he has a different set of problems and issues than we have. He has so much capital, he needs to find a way to put large amounts of capital to work on a consistent, predictable basis, and so a utility or a railroad makes a lot of sense if you need to put a lot of capital to work and have a high degree of confidence you're going to make a return.

We don't have excess capital. We are comfortable with the amount of money we have to invest, and we still feel like we have a lot more flexibility and freedom to find, in some cases, smaller businesses that could grow a lot but that don't require as much capital.

I hesitate to speak for him, but I think he would agree it's always better to invest in an asset-light business, if you can find it. There are great businesses out there that are more capital-intensive and will warrant a look for time to time, but I think in general we have a lot more flexibility given our size than he might have.

McDevitt: Looking at the fund itself, you have done a lot of hiring here in the last decade or so. I'm curious where you are allocating your analysts on the fund and what are the new analysts bringing to the table in terms of the research effort?

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Poppe: We have grown the research staff quite a bit, and we are a lot broader in terms of the research efforts than we were even 10 years ago. I think, if you look back at the Sequoia Fund in the late '90s, it was dominated by financials; that's banks and insurance. And Bob Goldfarb, our current CEO, and Bill Ruane, our founder, had enormous expertise in that area.

I think over time, we still believe in running a very concentrated portfolio, but we have tried to add expertise in other areas, so we have hopefully as much expertise in half a dozen or 10 different sectors as maybe we had in financials 10 or 12 years ago.

We're looking more outside the United States--not doing a whole lot--but looking more at European companies, in particular, that do a lot of exporting to the emerging world, trying to access or get access to faster growth, and we've just looked at whole plethora of things.

We are still generalists; we're still not committed to 10% of the portfolio in industrials and 10% in financials, but we are trying to look at more manufacturers, more industrial distribution, more retail in some cases, and it has worked.

The portfolio today is about 35 stocks, in the late '90s it might have been 10 or 12 stocks. We are much less dependent on Berkshire Hathaway today than we were 10 or 12 years ago, but so far that's worked out OK. We still believe in concentration, but we think we can manage a 30-stock portfolio, in part because we have beefed up the research effort. We are at least double what we were 10 years ago in research.

McDevitt: That anticipates my next question I was going to ask, do you see this continuing--do you see the fund becoming more diversified, less concentrated, or are you comfortable where you are now in terms of the number of holdings?

Poppe: I am comfortable where we are right now. That's not to say we won't have a few more in the future. But one thing I would say is we have about 35 holdings right now. The reality is, probably the bottom 8 or 10 are 1% of the portfolio. So we have either some things we tried to buy, but we couldn't get the price we wanted. The price ran away from us. Or maybe some things we are in the process of selling. It's about a 25-stock portfolio that's meaningful to the investors. So there are more names in there than there is meaning.

But I think 25 to 30 stocks is probably a good meaningful position, probably a good level for us. We don't want to be diversified. We want to continue to concentrate in our best ideas.

The top 6 ideas in Sequoia are still more than 40% of the portfolio. We like that. So, right now we are happy looking at more things, seeing how good we can be in different sectors, but still concentrating most of our capital or much of our capital in our half-dozen best ideas.

McDevitt: Also, the fund has about 25% or so in cash, at least as of the last portfolio, and that's a relatively high level, not necessarily within the last two or three years, but looking back perhaps within the five or six years before 2008, you were more fully invested then.

How is it now in terms of finding opportunities, in terms of valuations? Do you see the cash level staying where it is? Are you not finding enough opportunities to take cash down?

Poppe: My answer is a strange one, because we are finding opportunities. We built the portfolio probably from 25 positions to 35 positions just over the last couple of years. We found things. We haven't always put enough capital into the new ideas, or we have been really picky or conservative on price and having wanted to pay up. So we have ended with positions that's sometimes are one-tenth of 1% of our assets, which is not a smart way to run the portfolio.

We are finding ideas. It is harder right now, and the 20% cash position is not a function of a call on the markets or trying to time the market. It's really more a function of maybe we got too conservative on the prices we wanted to pay for things, and we didn't buy enough of them, but we have actually been finding ideas.

So that's sound contradictory, but it's actually what's happened. We have cash. I don't think in the immediate future, we are going to become fully invested, but we also have ideas.

McDevitt: Sure. Again that speaks to the increase, the actual capacity you have added on the analyst staff.

Poppe: We are looking at more ideas and looking in more places. We have done more in the U.K. in the last couple of years than we had ever done in 40 years, 35 years prior. So we are looking at more ideas. It takes time to become confident that you are as good in the U.K. or Germany as you are in the United States, just because our CEO, Bob Goldfarb, 66, he has been doing this for 40 years. He is fairly encyclopedic in the United States, and we're not encyclopedic always in another markets. So it takes time.