Quick Take: When Diana Strandberg joined Dodge & Cox in 1988, the firm had only recently begun following global companies. It wasn’t until May 2001 that the San Francisco-based asset manager launched the Dodge & Cox International Stock Fund (DODFX), with Strandberg among its seven-person management team.
The fund quickly bore fruit in its first four years. As of Nov. 30, 2005, the $11.1-billion portfolio returned 17.4% for the one-year period, versus a 13.4% gain for its international equity peers; and climbed 29.1% (annualized) over three years, compared with a 18.6% performance by the peer group.
Low expenses are another attraction. The fund’s 0.77% expense ratio is less than half of its peers’ 1.57% average. With 74 holdings, the fund’s turnover rate is a minuscule 6.0%, compared with the peers’ 72.4% average. The fund’s risk level is slightly higher, with a standard deviation of 14.1%, versus 12.1% for the peers.
Top holdings as of September 30 comprised Mitsubishi Tokyo Financial Group Inc., 3.2%; News Corp. `A` (NWS.A), 2.9%; Matsushita Electric Industrial Co. Ltd. (MC), 2.8%; GlaxoSmithKline plc ADR (GSK), 2.7%; and Sanofi-Aventis ADS (SNY), 2.7%. The fund’s largest sector weightings were financials (20.2%); consumer discretionary (17.2%); materials (11.7%); energy (9.7%); and information technology (9.3%). The fund’s top regional concentrations were in Europe (excluding U.K.), 36.5%; Japan, 24.7%; U.K., 9.8%; and Latin America, 8.2%. Emerging markets as a whole accounted for 14.7% of assets.
The Full Interview:
S&P: How would you describe your investment philosophy?
STRANDBERG: We want to be long-term owners of companies whose current valuations do not reflect their long-term earnings and cash flow prospects. We are considered a value manager, we don’t like to pay up for companies. We do our own research and look at industries globally. We focus on governance and transparency.
S&P: What is your investment strategy?
STRANDBERG: The fund uses the same strategy as our domestic equity accounts. The portfolio is managed by a seven-member International Stock Investment Policy Committee. In addition, the firm has 20 research analysts, each looking at two or three industries globally. Our analysts use screens and various metrics, depending on the industry. We want a 360-degree view of a company — a picture from customers, suppliers, management, competitors, and key stockholders — so we can formulate a view of its opportunity and risk and develop our own three-to-five-year forecast.
S&P: What is your decision-making process like?
STRANDBERG: The analysts typically have a list of companies they think could hold investment promise at some point. They write reports on companies they want to recommend, with financial models and other relevant information.
Our buy and sell criteria are based on fundamentals and valuations three to five years out, and we look at each investment on its merits. Does it have the potential to preserve our client’s capital and grow it in real terms? What could go wrong with the stock, and what might that look like in terms of cash flow, balance sheet, and income statement? What is a reasonable outcome? And if things go right, what might that look like?
If we invest in a company and the stock price goes down, we ask if it has become a better opportunity or if something has materially changed. If it’s gotten better, we are persistent investors. But if fundamentals deteriorate, we are willing to sell at a lower price than we paid.
S&P: Your benchmark is the MSCI EAFE Index. How large is your universe of stocks?
STRANDBERG: Our universe consists of companies with market caps of $1 billion and up, from everywhere in the world. That’s about 2,000-2,500 companies. EAFE comprises just the developed markets, and doesn’t include Canada. We picked the benchmark because it’s the one everyone seems to use, and we wanted to have comparability. At any rate, the portfolio isn’t constructed against the benchmark.
S&P: How do you manage risk in the portfolio?
STRANDBERG: We see risk as the potential for permanent loss of capital. We don’t define it according to volatility or benchmark measures. The EAFE does not represent a risk-neutral position. As a result, we’re willing to differ from the benchmark.
We think diversification is a powerful tool to help mitigate risk. We try to have representation in all major sectors and regions. While we’re willing to be different than the market, we want to be able to justify why we are or aren’t invested somewhere.
We also consider potential headline events that could impact the portfolio. Although we don’t take top-down views as we’re forming the portfolio, we do ask questions such as: are we exposed to a growing world economy? Do we have more defensive holdings, in case GDP doesn’t materialize as people expect?
S&P: As of September 30 the fund was overweight relative to the index in the consumer discretionary and information technology sectors, and underweight in financials. Why?
STRANDBERG: Consumer electronics and technology combined represent roughly 17% of our portfolio, versus about 7% of the EAFE. Over the past 18 months, profitability rose for many of these companies, but valuation did not. We thought the valuations were very attractive and began adding to our holdings.
Japan in particular was inexpensive. We found a lot of opportunities in consumer electronics and tech companies that were financially strong, focused on shareholder value, and had very low valuations. As of September 30, Dodge & Cox’s Japanese technology and consumer electronics companies traded at six times cash earnings, versus 10 times for the EAFE’s Japanese technology sector.
Financial services represent about 28% of EAFE, and about 20% of our portfolio. We’re even more underweight in European financials, which represent about 18% of EAFE and about 9%-10% of our portfolio. There are some wonderful companies in this sector, but many of them are trading at very high valuations in our opinion.
S&P: Could you single out a top holding and discuss how it reflects your investment style?
STRANDBERG: We’ve been long-term holders of Matsushita, the Japanese consumer electronics company. We like that it has low valuation on virtually every metric we look at, except earnings. Typical of Japanese companies, its margin structure is low relative to peers, but it is financially very strong and involved in lots of different businesses, with strong market positions. The management team is focused on profitability and willing to address what are their core businesses. Recently, the company repurchased shares and ramped up its restructuring efforts.
S&P: Do you hedge currency risk?
STRANDBERG: No, although by prospectus we can hedge up to 25% of the portfolio. In the long term, we think it isn’t going to add a lot of value. Instead, we look at currency at the individual investment level. For instance, before buying Standard Bank in South Africa, we asked where their costs revenues, assets, and liabilities were denominated. We had concerns about the level of the South African rand, which had run up significantly. So we depreciated the currency over our investment horizon, which gave us a construct as to how this company’s balance sheet and income statement would move around as the currency changed and whether it still would make sense as an investment.
S&P: What is your outlook for various global markets?
STRANDBERG: We don’t make predictions, per se. But we think that valuations are reasonable. Though stocks in general are not dirt cheap as they were a couple years ago, that doesn’t mean there are no opportunities.
Currency could be either a headwind or tailwind. This year it’s been a tremendous headwind. As of last night, the EAFE was up 24% in local currency terms, but up only 9% in U.S. dollars. We think we’ll have a more moderate return over the next year, in the high single- or low double-digits overseas. To be fair, I would have said that last year, too. So if I’m wrong, I would love to be wrong that way again.
Contact Bob Keane with questions or comments at: [email protected].