3.5 Rules from Ruane’s Harvard Professor
Before meeting Benjamin Graham and Warren Buffett, Bill Ruane got his first lesson on value investing from his Harvard professor, Albert Hettinger. In 1957, Hettinger left Harvard Business School and made a fortune on Wall Street. After going broke twice between 1932 – 1939, Hettinger earned his final success after reading Graham’s "Security Analysis." Hettinger gave Ruane 3.5 rules:
· Rule #1: Don’t borrow money. If you are smart, you don’t need to. If you are dumb, you don’t want to.
· Rule #2: Forget the level of the market. The only thing that matters is the specific situation having to do with your stocks.
· Rule #3: Concentrate on what you know best. Most of his money was in only six positions. Concentrate and know your holdings well.
· Rule #3.5: Look out for momentum. The psychology of the market can take the market up and down, much further than you think. Psychology feeds on itself.
Ruane’s Rule #1: Be a Meek Little Lamb Who Is Afraid of Being Fleeced
On Wall Street, a bullish investor likes to say: “I am a bull.” A bearish investor likes to say: “I am a bear.” In a letter to Fortune in 1988, Ruane said he was neither bear nor bull. “I have always thought of myself as a meek little lamb who is afraid of being fleeced.”
At the 2005 Sequoia Fund shareholders' meeting, Ruane offered two rules of investing, borrowed from his professor Benjamin Graham: '”Rule No. 1: Don't lose money. Rule No. 2: Don't forget rule number one.”
In essence, Ruane’s rule number one is the same as Graham’s rule number one, namely, be extremely risk-adverse.
Rule #2: Be Willing to Bet Big on the Right Opportunity
However, being a little lamb won’t make you a Superinvestor. You have to be a lion at the right time. That’s the hard part of the investment yin-yang. Ruane sometimes sat on the sidelines when stocks were overheated, but when he believed strongly in a stock, he was willing to bet big. For example, Berkshire Hathaway at times made up around 30% of the fund's assets. Other companies also often made up a big piece of the Sequoia pie. Ruane was usually comfortable with these large positions because of the wide margin of safety he required before investing. Even if things turned bad temporarily, the margin usually acted as a cushion, preventing any significant losses — this is value investing at its best.
Just like many other intelligent investors who surveyed the world of possible investment approaches, and given the obvious innate superiority of Graham’s arguments, Ruane settled on the value approach.
The Effort to Buy Quality at Prices Significantly Below Value Must Be Systematic
In a lecture at Columbia University, Bill Ruane started by declaring that he was convinced that successful investing entails a systematic effort to buy common stocks of quality companies at prices significantly below their intrinsic value. He defined intrinsic value as the price that would be realizable in the purchases and sales of the issuer’s going businesses negotiated by rationally motivated principals. Ruane's investing strategy mirrored Warren Buffett's, and not by coincidence. Both of these great investors studied under Ben Graham at Columbia University, and even worked for him for a while. That's why such terms as "intrinsic value" and "margin of safety" often showed up in Ruane's vocabulary.
Ruane looked for companies with sound finances and strong franchises, buying only the few whose stocks traded below their intrinsic values. Further, Ruane wasn't afraid to buck traditional money management trends when necessary. For example, while many managers were scrambling to chase hot stocks to fend off underperformance, Ruane's fund would often sit on a pile of cash when he believed stock prices were too high. This strategy certainly served shareholders well over time.
It Is Essential to Doing Your Own Research
Because Ruane’s value investment philosophy differed markedly from that of Wall Street in general, he had found it essential to do their own investment research rather than relying on outside research by sell-side brokers and the like. Insisting on doing their own research in house, Ruane built a reputation on Wall Street as an old-fashioned value investor expert at delving into a company's business and books to discover hidden worth.
The Functions of Research and Portfolio Management Should Not Be Separated
Ruane was convinced, too, that the functions of research and portfolio management should not be separated as they are in lots of other investment firms; for too much is lost in translating the essence of the research into portfolio actions. For this reason, the principals of his firm devoted the majority of their time to research and analysis of securities and the balance to the management of the portfolios assigned to them.
Next time, we will look at Bill Ruane’s secrets of building a successful investment advisory firm. Stay tuned.
Brian Zen, Ph.D., CFA, is founder of Zenway Group, a New York-based investment advisory firm helping families to acquire financial intelligence and achieve maximum financial results at minimum expenses and hassles. Dr. Zen appreciates your questions and feedback at: info (at) zenway.com.