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Value investing has been “out of favor” for several years with some calling the investment style dead. We believe the following is an interesting anecdote that helps place the current period in context.
Before running Berkshire Hathaway, Warren Buffett ran a hedge fund from 1956-1970. Over nearly a 15-year period, he delivered a record of performance that was legendary and easily trumped the US equity benchmarks (see end of post for returns table).
In 1969, Mr. Buffett announced to his investors that he would be liquidating the investment partnership, which had grown to reach an asset size of >$100M, to pursue other interests. In his letter to shareholders, he shared his negative view on prevailing equity valuations, recapped his performance record, and thanked everyone for years of faith and loyalty. Lastly and the reason for this note, Mr. Buffett made an unusually direct investment recommendation to his investors.
Before running Berkshire Hathaway, Warren Buffett ran a hedge fund from 1956-1970. Over nearly a 15-year period, he delivered a record of performance that was legendary and easily trumped the US equity benchmarks (see end of post for returns table).
In 1969, Mr. Buffett announced to his investors that he would be liquidating the investment partnership, which had grown to reach an asset size of >$100M, to pursue other interests. In his letter to shareholders, he shared his negative view on prevailing equity valuations, recapped his performance record, and thanked everyone for years of faith and loyalty. Lastly and the reason for this note, Mr. Buffett made an unusually direct investment recommendation to his investors.
Excerpt from 1969 Letter to Shareholders
Bill Ruane’s firm was Ruane, Cunniff & Stires Inc and they would eventually launch the Sequoia Capital Fund in 1970. This is the same Sequoia that would go on to deliver more than 30 years of dazzling performance under the management of Mr. Ruane. This rare indorsement from Buffett came at a time the markets were filled with excessive investor euphoria, enamored with things like the Nifty Fifty, and high valuations. As usual, Buffett took a long view on things and figured, over time, Mr. Ruane would be successful applying his “value investing” approach to navigating the stock market.
Excerpt from 1969 Letter to Shareholders
Unfortunately, any of his investors that followed Mr. Buffets advice would have had their confidence tested immediately. Beginning July 15, 1970 and through year end 1974, the fund entered a 4.5 year stretch of poor absolute and relative performance. By year end 1973, following a 25% loss in that year, an investment in the fund made in July 1970 would have been flat (net of fees) over this 42-month period (2nd worst in fund history). This added up to more than 1,000 basis points (bps) of annualized underperformance relative to the S&P 500, which was 40% higher over the same period. The following year Mr. Ruane fared better in relative terms but still poor on an absolute basis as the fund posted another loss of -16% for the period compared to the index’s loss of -27%. By year end 1974, a hypothetical investment made in July 1970, would be facing a cumulative 15% loss on capital for this 4.5-year period. This includes a 35% loss reported by the fund in just the preceding 2 years (1973-1974). For reference, the S&P 500 was flat during over this same period.
After this painful period, it isn’t hard to imagine at least some investors deciding to sell their shares at the end of 1974.
Over the next 5 years (from 1975-1979), Sequoia compounded capital at a 35% annualized return (4.6x ROI) vs. 15% for the S&P 500 (2x ROI). The fund delivered nearly 2,400 basis points of annualized outperformance per year. A $10,000 investment made in July 1970, the original starting period noted above, would now be worth nearly $39,000 (3.9x original investment) while a similar investment in the index would be worth just $20,500 with the difference translating to an annualized return of 15% vs. 8%.
Mr. Ruane went on to perform well ahead of the market for nearly the next 30 years though not without more periods of underperformance.
There were eleven separate 3-year periods of cumulative underperformance relative to the index and six 5-year periods. In fact, out of the 34 ½ years under review, the fund underperformed the market in 14 of those years or about 40% of the time. Unsurprisingly, during the height of the tech bubble in 1999, the fund generated one of its worst returns in history generating a -17% return while the index returned +21%, which represents about 3,800 bps of underperformance for this 12-month period. Fortunately, as the tech bubble burst, the fund was able to more than offset these losses ending the 5-year period of Dec 2004 with a cumulative return of 58% versus an index that had lost -11% of its value.
All in, from July 1970 – Dec 2004[1], the Sequoia fund delivered 16% annualized return outperforming the S&P 500 by 400 bps per year, turning $10,000 into more than $1.6 million or 3.5x an investment in the S&P 500 worth just $490,000 over the same period. Over a 34 ½ year period, this 400 bps points in annualized outperformance generated triple the return of the S&P 500.
Buffett Partnership Ltd. (Buffett’s
hedge fund) – Excerpt from January 1969 Partnership Letter
[1] (last calendar year end prior to Mr. Ruane’s death)
Disclosures: The views presented here represent the opinions of Adrian Morffi of SeaBridge Investment Advisors based on analysis of publicly available information. The opinions of other analysts based on these data may differ. The presentation is intended to illustrate the current thinking of the investment manager and is for information only. It should not be treated as investment advice with respect to any potential investment. It should not be considered a solicitation or offering of any specific investment products or services. There are no guarantees as to the accuracy of the interpretations of current or historical events or future prospects. The conclusions of the analysis may not be realized in the future. There may be errors in the data referenced in this analysis. Investment involves risk and past performance is not indicative of future performance.