jetcityimage
jetcityimage
The following segment was excerpted from this fund letter.
Shares in Charles Schwab returned -16% last year, making it the Fund's worst-performing stock. By holding steady in the down market of 2022, it was one of the Fund's best-performing stocks that year. This reversal in stock performance reflects a realization that rising interest rates are not an unalloyed good for Schwab in the short run.
When the regional banking panic broke out early last year, Schwab found itself being compared on Twitter and in the popular business press to Silicon Valley Bank and other failed banks. In our view, the analogy was, and remains, fundamentally flawed. It is true that Schwab has a large portfolio of US government and agency-backed securities whose value declined when interest rates rose, but that is where the similarity ends.
Over 80% of Schwab Bank's deposits are insured, and they are diversified across 35 million accounts. Schwab is also extremely liquid. Its bond portfolio is currently carrying significant unrealized losses, but, critically, they do not constrain the company's ability to sell bonds. Unlike most other banks, Schwab's binding regulatory ratio is Tier 1 Leverage. If Schwab were to sell a slug of its bond portfolio, its Tier 1 Leverage ratio would hold steady or perhaps even improve a touch. In short, we never believed that Schwab was at risk of a run on its bank. Client deposits were always safe, and the company always had plenty of liquidity.
Schwab's earnings are currently being squeezed to a significant extent. This squeeze can be attributed, in part, to the fact that clients are "sorting" out of low-yielding Schwab Bank sweep accounts into higher-yielding money market funds faster than Schwab's pile of interest-earning-assets is rolling over into the new and higher rate environment.
The existence of this asset-liability mismatch was not a secret. Schwab always knew, as did we, that it would take time for rising interest rates to translate into a higher net interest margin for the company. That said, we did not anticipate this mismatch to manifest as dramatically as it has. Interest rates rose faster and more significantly than they have in decades, and as a result Schwab's clients sorted their sweep cash faster and more significantly than they otherwise would have.
Keep in mind, though, that higher interest rates are still good for Schwab's earnings power in the long run. As shareholders, we have been rooting for an end to Zero Interest Rate Policy for years. Over time, higher interest rates should allow Schwab to earn more net interest income, as the increase in the company's long-term net interest margin should more than offset the decline in deposits at Schwab Bank. What makes the current moment awkward is that Schwab's deposits have already declined, whereas its net interest margin has not yet increased.
Exacerbating the situation is Schwab's current use of higher-cost short-term funding. As already noted, Schwab has plenty of regulatory headroom to generate funds by selling bonds. However, the company has instead elected to avail itself of this high-cost funding in order to avoid the irrational scrutiny that might accompany a bond sale program. We find Schwab's decision frustrating, but understandable.
These various dynamics are impacting Schwab's current earnings and will likely continue to do so for another year or two. However, we do not believe they will have any significant bearing on the company's earnings power in the long run. Critically, Schwab's enviable, high-return franchise is, in our view, entirely intact.
Schwab remains the preeminent public wealth management platform in the United States. With over $8.5 trillion in assets under management and nearly 35 million brokerage accounts, the company is now larger than the wirehouses it originally sought to disrupt. Even so, the company still only has a low-teens percentage share of total investable wealth, leaving plenty of room for Schwab to grow in the years and decades to come. The drivers of growth are scale, brand, and culture. Schwab offers low prices, excellent customer service, and an ever-expanding suite of products.
In 2023, Schwab made substantial progress on the integration of its landmark TD Ameritrade acquisition. Despite increased churn from transitioning TD clients to Schwab's platform, Schwab still attracted over $300 billion of core net new assets last year.
The regional banking panic in March of last year created an opportunity for us to add to our position below $50 per share. At the current share price, Schwab trades for a low-double-digit multiple of likely earnings per share out a couple years. We believe the stock will generate an attractive long-term return across a range of long-term interest rate scenarios.
| Disclosures Please consider the investment objectives, risks and charges and expenses of Sequoia Fund Inc. (the "Fund") carefully before investing. The Fund's prospectus and summary prospectus contain this and other information about the Fund and are available at Home - Sequoia Fund or by calling 1-800-686-6884. Please read the prospectus and summary prospectus carefully before investing. Shares of the Fund are distributed by Foreside Financial Services, LLC (Member FINRA).
* The Fund's holdings are subject to change and are not recommendations to buy or sell any security. The percentages are of total net assets. An investment in the Fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Shares of the Fund may be offered only to persons in the United States and by way of a prospectus. Annual Fund Operating Expenses (expenses that you pay each year as a percentage of the value of your investment):
** It is the intention of Ruane, Cunniff & Goldfarb L.P. (the "Adviser") to ensure the Fund does not pay in excess of 1.00% in Net Annual Fund Operating Expenses. This reimbursement is a provision of the Adviser's investment advisory contract with the Fund and the reimbursement will be in effect only so long as that investment advisory contract is in effect. The expense ratio presented is from the Fund's prospectus dated May 1, 2023. For the year ended December 31, 2023, the Fund's annual operating expenses and investment advisory fee, net of such reimbursement, were 1.00% and 0.89%, respectively. The Fund is non-diversified, meaning that it invests its assets in a smaller number of companies than many other funds. As a result, an investment in the Fund has the risk that changes in the value of a single security may have a significant effect, either negative or positive, on the Fund's net asset value per share. The S&P 500 Index is an unmanaged capitalization-weighted index of the common stocks of 500 major US corporations. The Index does not incur expenses. It is not possible to invest directly in the Index. | ||||||||||||||||||||||||||||||||||
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.