Quick Take: Going against the grain could sum up both the investment philosophy of Dodge & Cox Stock Fund (DODGX), as well as the corporate practices of Dodge & Cox itself, according to John Gunn, one of the fund’s managers and the firm’s president and chief investment officer. The fund takes a contrarian approach, picking up beaten-down stocks under temporary ‘clouds.’ But unlike most money managers, Dodge & Cox provides a similar portfolio of these very same stocks for the bulk of its clients.
Gunn believes investors, either in the fund or through an individual account at Dodge & Cox, benefit from many of the same stock holdings collectively, an approach shunned by most firms because of the profits they enjoy from constructing multiple offerings, he explains. Instead, Dodge & Cox stays focused on its core strength: building a portfolio of stocks of undervalued companies with attractive long-term prospects as judged by the firm’s 30-member equity-investment team.
Dodge & Cox Stock fund is the fifth-best performing large-cap value fund for the ten years through last month, returning an annualized 12.7%, versus 7.4% for the average large-cap value fund. For the three years through last month, the fund rose 2.4%, compared with a 7.9% decline for its peers. Based on quantitative and qualitative criteria, Gunn and the fund’s team were selected as one of 10 winners of the first annual Standard & Poor’s/BusinessWeek Excellence in Fund Management Awards.
The Full Interview:
S&P: You tend to hold stocks that do well over the long term. How do you find them?
GUNN: Our turnover is about 15% to 20%, and valuations are very important to us. We try to buy stocks of companies with durable business franchises for the next four to five years. We usually buy them when they are under a short-term cloud.
We try to avoid over-valued stocks. When considering a potential holding, we ask how it would do if we put it in a safety deposit box for four years. For the last three years, we’ve avoided two-thirds of the stocks in the S&P 500, because we thought they were overvalued. We believed if you put two-thirds of the S&P 500 in a safety deposit box, it would have shrunken considerably over the next four years.
S&P: A lot can happen to a stock in four years.
GUNN: We constantly look at our holdings. Everyday, you implicitly repurchase your portfolio if you don’t change it. We are always trading, but we don’t make huge shifts. We don’t think anyone can forecast short-term moves.
S&P: Why do few other funds follow your strategy?
GUNN: One key advantage we have is that we are independent. Dodge & Cox was founded in 1930 by Van Duyn Dodge and E. Morris Cox. They were disillusioned by the excesses of the 1920s equity market and firms making money from transactions, rather than from how the clients did.
Today, we manage about $70 billion in total net assets, with about $27 billion in mutual funds. We follow a very disciplined approach, and the equity portfolios for all our clients are very similar.
S&P: Many investment firms recommend customized portfolios for investors based on their particular circumstances.
GUNN: Few money-management firms follow our approach because you only have one product. Either it does well, or it doesn’t. Also, more products may mean higher profits for investment firms. We focus all our efforts on one portfolio and try to know our holdings as well as we can.
S&P: What are the main features of the fund’s management structure?
GUNN: About 30 investment professionals work on the fund, with ten in policy-making positions. It’s a group decision process — we don’t have a star management system. We continually put ideas through the gauntlet. We are contrarians, and stocks with low valuations often go through frightening things. When you’re whistling in a graveyard, you have to have someone holding your hand.
S&P: What are the most important investment themes in the fund?
GUNN: We are bottom-up investors. Consumer discretionary is our largest sector, but our holdings in that area range from Sony Corp. (SNE), to retail, to autos, to Whirlpool Corp. (WHR).
We focus on areas of long-term growth, which usually benefit from declining costs due to technological innovation. We hold Hewlett-Packard (HPQ) and Corning Inc. (GLW), which we previously sold and repurchased after they fell in price. We have a fairly large position in Xerox Corp. (XRX), and think its management is doing a lot of the right things.
S&P: Do you following any broad macroeconomic trends?
GUNN: We consider some top-down themes. We think the global economy is in the beginning phases of a long-term expansion. Over the next five to ten years, there won’t be much upside in U.S. consumer spending, and Europe and Japan have limited potential due to their demographics.
The key to global growth in the long term is the developing world. Citizens in the developing world are gradually organizing to produce and consume more. It’s a herky-jerky process. The only threat is insecurity and terrorism, but the U.S. is working to control these issues.
There’s no parallel in economic history for the potential growth of the developing world. Technology, particularly the declining cost of communication, will provide a big push. Sony will play a key part in this process.