Sagging Sequoia Fund Unveils Big Taxable Distribution

(SEQUX Quote)Sequoia shareholders have seen better days. The value fund has underperformed the S&P 500 for 10 years, and it added insult to injury this week by announcing a big distribution set for December.

Sequoia is a popular value fund that has been closed to new buyers since 1982. It slipped to a loss of 16.5% last year, compared to a gain of 21% for the S&P 500, putting it at the bottom of its peer group, and over 10 years it has returned 16.7% to the S&P's 18.2%, figures on its Web site show. The fund has recovered a bit this year, but with a year-to-date return of 2.4% as of Aug. 29, according to Morningstar, it isn't exactly sprinting past its competitors.

And shareholders never like distributions -- payments to shareholders based on dividends or capital gains -- because they have to pay taxes on them. But there may be a silver lining in this cloud: The distribution signals that the fund, which has been criticized for being stagnant, may be starting to shake up its holdings.

This distribution should be a large one, stemming mostly from capital gains from selling its stock in mortgage lender Freddie Mac (FRE Quote), Morningstar analyst Michael Gaul says. Although Sequoia would not comment, it wrote in its semiannual report on Aug. 29 that the distribution would likely be more than $20 a share -- about 15% of Sequoia's net asset valuation of $129.81 as of Aug. 29, according to Morningstar.

Still, some Sequoia shareholders may see the distribution as a breath of fresh air, since the fund's stodgy long-term buy-and-hold strategy has drawn fire in a changing stock market. Having sold Freddie Mac as well as motorcycle maker Harley-Davidson (HDI Quote), the fund managers seem to be ready to make some more moves.

"Maybe it shows that the fund's not frozen -- the mangers aren't frozen in activity," Gaul says. "The sales show that they're willing to take activity and still act on their convictions."

Large capital gains on the sale of Freddie Mac also show that Sequoia's investment over the long term was a good one. "Freddie Mac has been a great stock for them through most of the '90s, and I think most of the shareholders in the Sequoia fund appreciate that," Gaul says.

Meanwhile, there isn't much reason for Sequoia to plan the distribution for any earlier than December, when it typically makes such moves. Since the fund is closed, the potential tax bite can't exactly scare away possible investors.

Gaul says he doesn't think the fund will sell its stock in other companies to realize losses that could reduce the distribution, either. "The managers have said that if there are fundamental reasons for them to sell, they're going to do that, with tax considerations being secondary," he says. "That's kind of been their stance in the past."

Sequoia can relieve large shareholders -- most likely those who have at least $1 million in the fund -- by giving them shares of some of the stocks it owns, rather than a cash distribution. Shareholders pay taxes only on cash gains.