The Sequoia Fund vs. Conoco Phillips

For those of you that keep up with your stock market history, you know that the Sequoia Fund was the mutual fund that Warren Buffett recommended investors should choose during his transition period between closing down his privately run partnership and gaining control of Berkshire Hathaway. Investors listening to Buffett would have been well-rewarded for following his advice, as the Sequoia Fund is one of the best performing mutual funds of the past half-century.

But one thing I do want to show you is that active management, even when it is well-earned, does carry consequences. For a moment, let’s hop back in the wayback machine and travel to December 31st, 1981, the first day on which I can find publicly accessible trading data for the company that is now Conoco Phillips.

At that time, an investor could have been mulling two decisions: to invest $10,000 into shares of Conoco (the Phillips side of the equation didn’t come until a merger in 2002) or to put $10,000 into shares of the legendary Sequoia Fund. You could easily understand why an intelligent steward of long-term capital might do either: Conoco was the fifth largest integrated oil company in the world, allowing it to benefit from diversification of upstream and downstream assets during periods of economic turmoil, yet it was still smaller than its peers Exxon and Chevron and plausibly had the ability to use this to its advantage to possess a higher long-term growth rate.

The Sequoia Fund was, well, the Sequoia Fund. The management allocated a big block of its investment capital to Berkshire Hathaway (for long periods in its history, Berkshire made up ~10% of the fund) and was developing a reputation for sticking to its value investing prescription even through the early 1970s when the managers were trailing the S&P 500 substantially, giving the fund appeal to serious people that like to see a strategy followed even when it becomes unfashionable to do so.

Either way you looked at it, having to choose between The Sequoia Fund and ConocoPhillips was a first-world dilemma, and the selection of either was unlikely to disappoint over the coming 20+ years.

As we review the history of each, we can see the following: Since December 1981, the Sequoia Fund has delivered 13.29% annual returns, seemingly turning that $10,000 investment into $630,000. If you were 35 years old at the time you made that investment, you would have a net worth roughly 5.16x your peers of the same age right now, from that investment alone. Had you chosen Conoco, you would have compounded your wealth at 13.17%, turning a $10,000 investment $554,000 (this assumes you rolled the shares created from the Phillips 66 spinoff back into Conoco at the date of the spinoff). Based on Conoco’s 3.46% dividend yield at the time of writing, you would be collecting $19,168 in annual dividends from your investment. Not only would you be one of the few mortals to be collecting more annual income from an investment than you actually put into it, but you would be quickly closing in on the point at which you would be collecting your initial investment in dividend income alone every six months.

But some of you can already see where I am headed: the Sequoia Fund was not managed for free on your behalf over the past 33 years. There is nothing immoral about that; the Sequoia Fund had work to do, and they did it well. But since it is after-tax, after-fee returns that determine the size of the tuition checks you write, down payments you make, and retirement nest egg that you accumulate, you should take a clear-eyed view of the effects of fees upon total results, specifically over long periods of time.

In the case of the Sequoia Fund, the management team charges 1.00% annually to manage your money (this is below the industry average of 1.2% or so for large-cap American funds, and seems warranted based on the Sequoia Fund’s long-term ability to deliver on the promise of superior returns). According to the SEC, you would have paid out $40,000 in fees for the Sequoia Fund over the past 33 years, roughly four times the amount that you had set aside to invest. Furthermore, there is the matter of foregone earnings: when $100 is turned into $99, you don’t have that $1 compounding at 13.29% for the next 33 years.

sequoia

According to the SEC, the Sequoia Fund investment would have a value of $440,000, a little over $100,000 less than the Conoco investment, despite the superior compounding rate.

This isn’t meant to be a knock on financial advisors or mutual funds necessarily. The Sequoia Fund has done a lot of good for people over the past three plus decades—kids are graduating from American universities debt-free, couples are vacationing on Folly Beach in South Carolina, and retirees are enjoying steak dinners worry-free because William J. Ruane and Richard T. Cunniff graced this earth and put their talents to productive use.

But it should place one idea firmly in your mind: the fewer layers of management standing between you and your money, the better (almost always). There is a reason why I write about blue-chip stocks here rather than mutual funds. Mutual funds can be an important part of the wealth-building process, particularly within 401(k)s where there can be lower fees for these popular funds due to negotiation between your employer’s agents and the fund family. The revolution at Vanguard happened because John Bogle said, “Hey, look at how your wealth compounds when we only charge you 0.10%.”

The situations I write about are often even better than that, as you only have to pay an initial $10 fee to get your hands on the asset yourself. Those 1% fees hidden in the investment prospectus add up over a lifetime. That’s why, during bull markets, mutual fund investors often experience that sensation that they are doing well, but not quite as well as the headlines seem to indicate. Having your assets wrapped up in layers siphoning off 0.083% of your net worth every thirty days can easily be avoided if you set your mind to asset ownership outright.