Date
22 October 2017
Canadian drugmaker Valeant saw its shares plunge after it uncovered accounting irregularities and warned of a debt default. Photo: Reuters
Canadian drugmaker Valeant saw its shares plunge after it uncovered accounting irregularities and warned of a debt default. Photo: Reuters

The fundamental lesson of the Sequoia fiasco

Renowned US hedge fund Sequoia suffered huge losses following heavy bets on Canadian drugmaker Valeant, according to a recent report.

Its long-serving fund manager Robert Goldfarb has resigned.

The case reminds me of the two sides of the investment world: the overnight success and the loss of everything in one day.

Sequoia was founded in 1970 and started out with only US$10,000 of assets under management. During its heyday, it offered returns about four times more than the S&P 500, the highest in the industry.

Unfortunately, Goldfarb placed too much bet on Valeant, at one point as much as 32 percent of the fund’s portfolio.

The stock has fallen nearly 90 percent from its peak last summer, causing Sequoia to lose 25 percent of its asset value in the past year.

Investors rushed to withdraw their money from the fund. From last August to February, Sequoia’s clients drained nearly US$800 million from the fund. Some even filed lawsuits.

Among the fund’s five independent directors, two have jumped ship.

However, the strategy itself, of putting a heavy load on a few stocks, is neutral. There have been successful cases, like John Paulson, who won US$15 billion from shorting subprime house loans before the night of the global financial crisis.

Actually, Sequoia has never been a fund with diversified stock allocation. Its main strategy has always been to put big chips in five or six selected stocks.

Before the Valeant fiasco, who ever doubted the strategy?

With one stock accounting for one third of the portfolio, a price had to be paid sooner or later.

The failure of Sequoia is a perfect negative case to teach investors an important lesson in risk control.

This article appeared in the Hong Kong Economic Journal on March 29.

Translation by Myssie You

[Chinese version 中文版]

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MY/DY/CG

Columnist at the Hong Kong Economic Journal

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