Market for Bootleg Sequoia Shares Wanes as Fund Slumps

(SEQUX)Sequoia may no longer be the best-selling fund investors aren't allowed to buy.

The no-load fund has been closed to new investors since December 1982. But its years of steady, solid performance have motivated many crafty investors to open an account by paying a current shareholder a hefty premium for a single share.

A minus 15.1% return for the past 12 months has tarnished the fund's once-impeccable performance record, though. Now the gray market, in which hard-to-get shares of the fund traded for as much as seven times their nominal value, appears to be drying up.

A heavy bet on Berkshire Hathaway (BRK.A) and financial stocks has led to a tough year in which the fund ranks in the bottom 1% of its large-cap value category, according to Morningstar.

This sad showing contrasts sharply with a long-term performance that ranks among the top 10% of large-cap value funds over the past three-, five-, and 10-year periods.

Sequoia's Diminishing Returns ...

... Lead to a Plummeting Category Ranking Source: Morningstar; large-cap value funds category

Since the fund's inception in July 1970, managers William Ruane and Richard Cuniff have followed Warren Buffett's value-oriented investment philosophy, running a heavily concentrated, low-turnover portfolio. (Current manager and fund president Robert Goldfarb has run the fund with the same strategy since July 1998.) In fact, Buffett's holding company, Berkshire Hathaway, is the fund's top holding, representing a whopping 29.9% of the fund's assets -- a position worth more than $1 billion.

In the past, this approach has posted solid returns. Like Berkshire Hathaway, Sequoia's investment approach focuses on financial stocks, which have been hurt lately by fears of rising interest rates and an expensive hurricane season. (Higher rates can pare bank profits, and natural disasters boost property/casualty insurers' payouts.)

Of the fund's 10 largest stock holdings, eight are financials and six have returns that are in the red this year. In the fund's semiannual report, Goldfarb admits to having difficulty finding stocks of solid businesses that are selling at attractive prices. This might explain the fund's 18% cash position in June. Sequoia and Berkshire Hathaway officials did not respond to requests for comment on this year's performance.

Sequoia's Top Holdings Berkshire and the banks seem to be bad medicine for the fund so far this year.
Stock	Sector	YTD Return	% of Net Assets
Berkshire Hathaway (BRK.A)	Financial	-18.0%	29.9%
Freddie Mac (FRE)	Financial	-16.9	15.8
Progressive (PGR)	Financial	-47.8	11.9
Fifth Third Bancorp (FITB)	Financial	-6.9	8.5
Harley Davidson (HDI)	Durables	16.1	5.6
US Bancorp (USB)	Financial	-3.9	3.0
Household International (HI)	Financial	13.2	1.8
National Commerce Bancorp (NCBC)	Financial	23.2	.5
Mercantile Bankshares (MRBK)	Financial	-14.9	.3
Sturm, Ruger & Company (RGR)	Industrial	-19.5	.1
Source: Morningstar; holdings as of June 30; performance as of Oct. 8

Sequoia's value orientation has caused it to lag behind its large-cap-growth peers as value stocks have only experienced brief run-ups over the past two years and financial stocks have fallen harder than other value sectors. This might make impatient investors lose their appetite for bootleg shares.

But at least one back-door shareholder, Greg Stehler of Uniontown, Ohio, is still happy with his investment in the fund, despite the premium he had to pay to get in.

Stehler was planning to invest in Sequoia in 1982 when the fund closed, shutting him out -- or so he thought. Last fall, 16 years later, he and a friend created a Sequoia Web page to advertise his interest in buying a share. He got five offers, and paid "around $750." Some offers topped $1,000. The fund's share price at Tuesday's close was $131.83.

The seller notified the fund company that the share was transferred to Stehler. A few days later Stehler was notified that he had an account and he mailed in a check, no questions asked.

What Stehler did seems to be a common practice. "When Sequoia closed in '82, it had $247 million. Now it's over $5 billion. I'd love to know how much of that is through bootleg investments," says Sheldon Jacobs, editor of the No-Load Investor newsletter.

But an unscientific review of mutual fund message boards on the Internet finds that interest in the fund may be waning. Offers to sell Sequoia shares outnumber bids to buy, three to one. A posting from last week offers a share for $700. No one has posted a reply yet. A more original September posting offers to exchange one Sequoia share for shares of another closed fund, (WEHIX)Weitz Hickory. This offer finds two takers.

"There's no point in the world to bootleg a share or two now," Jacobs says.

But there is good news for those who paid a premium to get into the fund. Many portfolio managers think its focus on financial stocks may pay off down the road.

"There's uncertainty in the financials as people wonder how rates will affect them, but we don't share that pessimism. We're buying them now," says Greg Conway, a portfolio manager with Conway, Jarvis & Associates in Seattle.

"Holding Berkshire Hathaway has obviously been a good thing until now and Buffett is a solid Graham and Dodd value investor," says Bruce White a private money manager with Clifford Associates in Pasadena, Calif.

Still, Stehler thinks other bootleggers may hold off buying shares, and those who've already bought in may sell out. But after waiting 16 years to get his hands on Sequoia shares, he'll hang on. "Demand for shares is probably down. But the fund just seems to be out of favor, everybody's going for these tech stocks. I'm in it for the long term, though."

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