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Sequoia Fund Stunk; Here’s Your Chance To Buy Sequoia Again
FYI: Now is your chance to buy into recently troubled Sequoia Fund (SEQUX). The fund’s manager, Ruane, Cunniff & Goldfarb, announced in a securities filing on Friday that shares are available to new investors who purchase them directly from the fund and existing shareholders who wish for a larger portion. It remains closed to new investors through other sales channels. The fund had been closed to new investors since late 2013 Regards, Ted http://blogs.barrons.com/focusonfunds/2016/04/29/sequoia-fund-stunk-heres-your-chance-to-buy-sequoia/tab/print/
One of the "complaints" investors were raising is that their larger ($250K+) redemptions were being paid in-kind. Just like an ETF. While it is quite likely you're correct about the existence of gains, it's not so clear that the gains have remained inside the fund (to be distributed this year).
I have no idea how to estimate how much gain was offloaded this way. Holding off (in a taxable account) is certainly prudent. It will be interesting to see how much in gains are left in the fund to be distributed to remaining shareholders.
This is one of the things I don't completely understand. If someone sells their Sequoia shares and gets loaded with a tax obligation that doesn't relate to their ownership of the fund wouldn't that somehow be a potential problem from a legal point of view? On the other hand, I myself have sold shares of a fund before a distribution because I didn't want the tax hit and presumably that redistributes the tax hit to all remaining investors. That could be deemed similarly unfair. In the first case, however, the fund is making a choice against one investor vs. others whereas in the second case the fund has no role in my decision to redistribute the tax obligation to others. Maybe both are perfectly legal, I don't know, but it seems like it could end up being the source of additional problems.
When you sell shares, you realize a capital gain or loss regardless of how you're paid (in cash or in stocks that Sequoia gave you instead). If you get stocks, their basis is what you "paid" for them, i.e. the value of the Sequoia shares you just traded in. So if you flip those stocks immediately, you have no additional gain or loss.
So where did the gain on the underlying stocks go? The general rule is when a company (such as a mutual fund) sells stocks it owns, it recognizes a gain or loss. It might sell stocks to raise cash for your redemption. Or it might "sell" you those stocks directly (redemption in-kind) to meet your redemption request.
But there's one special line in the tax code (IRC 852(b)(6)) that says this general rule doesn't apply to redemptions in kind for registered investment companies (mutual funds, ETFs). Poof! No cap gain - no gain passed through to you, no gain for the fund.
Your "on the other hand" description is right, but usually not as much of a problem as it might appear. If you've owned the shares awhile, your shares may have gone up 25% since you bought them, while the fund is planning a 20% gains distribution. If you were to redeem your shares, you would wind up recognizing a 25% gain, rather than get the 20% distribution. So you might grin and bear it - at least you're not recognizing more gain than you actually made with the investment. Expensive, but not really unfair.
Investors who held their shares for fewer years (say their share prices are up 15%) are the ones who would be inclined to sell. Otherwise, they would recognize gains greater than what they'd made in the fund. As you wrote, that means that more gains would be distributed to the remaining shareholders. So instead of a 20% distribution, the fund might wind up making a 23% distribution. Still not enough to induce you (with 25% share appreciation) to sell, but there could be a few other shareholders with 22% appreciation who would now decide to sell. Ultimately, an equilibrium point is reached.
All this assumes people are astute about their tax situations and act rationally. That's your laugh for the day.
Actually, in reading over Dodge & Cox's Prospectus recently (was having trouble falling asleep) I came across language that looks similar to Sequoia's. It's in the generic portion which applies to all their funds. This might might pull-up the prospectus: https://www.dodgeandcox.com/pdf/prospectus/dc_statutory_prospectus.pdf
Language: "Redemptions-in-kind The Funds reserve the right, if conditions exist which make cash payments undesirable, to honor any request for redemption by making payment in whole or in part in readily marketable securities chosen by a Fund and valued as they are for purposes of computing a Fund’s NAV. If payment is made in securities, a shareholder may incur transaction expenses in converting these securities to cash. The Funds have elected, however, to be governed by Rule 18f-1 under the Investment Company Act, as a result of which a Fund is obligated to redeem shares, with respect to any one shareholder of record during any 90-day period, solely in cash up to the lesser of $250,000 or 1% of the net asset value of the Fund at the beginning of the period." ---
On the broader subject, I'll maintain that focused funds like Sequoia are inherrently hazardous, for the obvious reason (because they focus on a narrow group of equities). And in today's climate, with the floods of performance-chasing hot money running in and out, I'd think they're even more hazardous - game of musical chairs. (Last one out - please turn off the lights.)
But just for old time's sake, here's GW Bush's classic "Fool Me Once."
Comments
I have no idea how to estimate how much gain was offloaded this way. Holding off (in a taxable account) is certainly prudent. It will be interesting to see how much in gains are left in the fund to be distributed to remaining shareholders.
So where did the gain on the underlying stocks go? The general rule is when a company (such as a mutual fund) sells stocks it owns, it recognizes a gain or loss. It might sell stocks to raise cash for your redemption. Or it might "sell" you those stocks directly (redemption in-kind) to meet your redemption request.
But there's one special line in the tax code (IRC 852(b)(6)) that says this general rule doesn't apply to redemptions in kind for registered investment companies (mutual funds, ETFs). Poof! No cap gain - no gain passed through to you, no gain for the fund.
Your "on the other hand" description is right, but usually not as much of a problem as it might appear. If you've owned the shares awhile, your shares may have gone up 25% since you bought them, while the fund is planning a 20% gains distribution. If you were to redeem your shares, you would wind up recognizing a 25% gain, rather than get the 20% distribution. So you might grin and bear it - at least you're not recognizing more gain than you actually made with the investment. Expensive, but not really unfair.
Investors who held their shares for fewer years (say their share prices are up 15%) are the ones who would be inclined to sell. Otherwise, they would recognize gains greater than what they'd made in the fund. As you wrote, that means that more gains would be distributed to the remaining shareholders. So instead of a 20% distribution, the fund might wind up making a 23% distribution. Still not enough to induce you (with 25% share appreciation) to sell, but there could be a few other shareholders with 22% appreciation who would now decide to sell. Ultimately, an equilibrium point is reached.
All this assumes people are astute about their tax situations and act rationally. That's your laugh for the day.
Language: "Redemptions-in-kind The Funds reserve the right, if conditions exist which make cash payments undesirable, to honor any request for redemption by making payment in whole or in part in readily marketable securities chosen by a Fund and valued as they are for purposes of computing a Fund’s NAV. If payment is made in securities, a shareholder may incur transaction expenses in converting these securities to cash. The Funds have elected, however, to be governed by Rule 18f-1 under the Investment Company Act, as a result of which a Fund is obligated to redeem shares, with respect to any one shareholder of record during any 90-day period, solely in cash up to the lesser of $250,000 or 1% of the net asset value of the Fund at the beginning of the period."
---
On the broader subject, I'll maintain that focused funds like Sequoia are inherrently hazardous, for the obvious reason (because they focus on a narrow group of equities). And in today's climate, with the floods of performance-chasing hot money running in and out, I'd think they're even more hazardous - game of musical chairs. (Last one out - please turn off the lights.)
But just for old time's sake, here's GW Bush's classic "Fool Me Once."