Dodge & Cox Funds Offers Prudence, Steady Returns

The 71-year-old fund firm of Dodge & Cox is the kind of place that gives stodginess a good name.

Meet the Family

Dodge & Cox Funds

Assets Under Management: $46 billion

Percentile Rank of Average Fund Over Three Years (1=Best, 100=Worst): 15%

Family's Top Three Stock Holdings: Golden West Financial, Bank One, Union Pacific

Minimum Initial Investment: $2,500

Meet the Family Q&A: Dodge & Cox Stock manager John Gunn

Web site: www.dodgeandcox.com

It doesn't advertise, nor does it offer any of the sexy sector funds that have enticed new investors over the last few years (and then broken their hearts). It runs only three plain-vanilla funds: (DODGX Quote)Dodge & Cox Stock, (DODIX Quote)Dodge & Cox Income and (DODBX Quote)Dodge & Cox Balanced. Last year through November, it ranked 555 out of 604 companies in terms of fund sales.

On the heels of several years of momentum-fueled frenzy, its investing strategy sounds downright quaint. "We ask ourselves how we would invest today if we were going to lock it up in a safety deposit box for four to five years," explains Chief Investment Officer John Gunn, who joined the company out of Stanford business school in 1972 (Check out TSC's interview with Gunn.)

This all may sound like pretty unexciting stuff. But in the super-volatile markets of the last couple of years, it's an approach that's proven its mettle. Dodge & Cox's equity fund posted healthy gains both in 1999 -- a killer year for many value funds -- and 2000, when it finished up 16.3%.

Granted, the fund will never generate a windfall. Its slow, steady returns may look dull to investors milk-fed on triple-digit gains. And over the last couple of years, some investors did lose patience: According to fund tracker Financial Research, Dodge & Cox's retail funds saw outflows of $1.6 billion in 1999. Last year, another $435 million left the funds through November.

But if they're not a ticket to fast riches, neither are Dodge & Cox funds likely to lose much in the down years. The last time the equity fund lost money was 1990, when it finished down 5.09%, according to Morningstar. Going as far back as the mid-70s (the fund's been around since 1965), it was in the red only two other times, with the greatest loss being 6.1% in the bear market of '77.

The 10 Most-Held Stocks in the Family
Stock	52-Week Performance
Golden West Financial (GDW Quote)	89.4%
Bank One (ONE Quote)	23.0
Union Pacific (UNP Quote)	13.7
Loews (LTR Quote)	60.0
Phillips Petroleum (P Quote)	24.4
May Department Stores (MAY Quote)	4.8
Alcoa (AA Quote)	-21.4
Occidental Petroleum (OXY Quote)	11.0
Genuine Parts (GPC Quote)	5.4
Unocal (UCL Quote)	4.3
Source: Marketguide.com. Data as of 1/12/01.

"The key to making money is not to lose it first," Gunn says. "You might even think of that as an investment Hippocratic oath: First, do no harm." While that kind of an attitude won't translate into standout years, Dodge & Cox's long-term record is solid: Over the last decade, it outperformed the S&P 500 by 0.4%, with annualized returns of 17.85%, according to Morningstar. That record earns it a ranking in the top 13% of its peers.

The company's bond fund ranks in the top 17% of its peers over 10 years, with annualized returns of 8.38%. The balanced fund, a hybrid of the equity and bond funds, ranks in the top 6% in its category over 10 years, with annualized returns of 14.49%.

Dodge & Cox Stock also managed to beat the S&P 500 by 1.66% over the last three years, a period when many value funds were just trying to keep their heads above water. To some degree, that's a payoff for consistency. According to Gunn, about 60% of the fund's portfolio today consists of stocks it held at the end of 1997. In between then and now, the fund had its worst year of relative performance -- trailing the S&P 500 by 23.2% in 1998, when it finished up 5.4% -- and its best year, beating the index by 25.4% in 2000. "In a relative performance sense, we had the worst year and then the best year with a lot of the same stocks," points out Gunn.

"Our conviction was tested pretty strongly in 1998," says Portfolio Manager Wendell Birkhofer.

Behind the turnaround last year was a timely decision to back out of tech stocks in the fourth quarter of 1999, based on their high prices. The tech names the fund held on to, like Thermo Electron(TMO Quote) and NCR(NCR Quote), enjoyed big advances in the midst of the downturn, posting respective gains of about 98% and 30%. (On the down side, the fund also held on to Xerox (XRX Quote), which has plummeted 72% over the 52-week period.)

Other prescient moves: Betting the price of oil would rise, Dodge & Cox bought into companies focused on the exploration and production end, like Baker Hughes(BHI Quote) and Anadarko(APC Quote). And in financials, insurance picks like Loews(LTR Quote) and St. Paul(SPC Quote) likewise saw big gains.

Dodge & Cox Fund Family
Fund	Net Assets, in Billions	1-Yr. Return	1-Yr. % Rank in Category	3-Yr. Return	Expenses	Date of Inception
(DODGX Quote)Dodge & Cox Stock	$5.7	13.35	16	15.12	0.55	01-04-65
(DODBX Quote)Dodge & Cox Balanced	$4.9	13.65	8	11.89	0.53	06-26-31
(DODIX Quote)Dodge & Cox Income	$1.0	12.41	19	5.74	0.46	01-03-89
Source: Morningstar. Data as of 1/11/01.

Performance isn't the only reason Dodge & Cox deserves a closer look. Its no-advertising policy means investors don't get saddled with the 12(b)-1 fees levied by many no-load funds (which use the money for marketing). Operating expenses for Dodge & Cox Stock are only 0.53%, compared with the 1.44% charged by the average domestic stock fund. Basically, investors in the fund are getting a discount of 63% off the average expense ratio for U.S. equity funds. The same holds true for the bond fund, with expenses of 0.46%, compared with an average for the category of 1.11%. (Low expenses go a long way toward boosting bond fund performance. Because bonds post lower returns than stocks over time, high expenses can be a real drag on their performance).

The equity fund's 18% turnover is also far below average, and means less money will be lost to taxes. Last year the fund did have a sizable capital gains distribution, but Gunn says that's unusual, reflecting gains taken in richly valued tech stocks before the market slumped. The fund's five-year average tax-efficiency ratio of 85.13% (meaning it lost about 15% of its gains to taxes) ranks it in the top 11% of its peers.

Another plus: The managers at the equity fund have been around a while. According to Morningstar, only one of the equity fund's eight portfolio managers has been there for less than 15 years; Gunn has been there for 29.

When it comes to stock-picking, Dodge & Cox seeks to buy durable business franchises, a term referring to both financial stability and the strength of the business model. It's also on the lookout for companies that could post positive earnings surprises in the future. Potential buys are vetted by a 27-member team of managers and analysts who aim to keep the portfolio diversified as a safeguard against losing money. Notwithstanding their conservative bent, Gunn says managers also want to own some stocks in growth areas, which range from pharmaceutical and health areas to communications and emerging markets plays.

Gunn says companies used to approach Dodge & Cox with an eye to acquisition, but they've been turned down so many times they've stopped calling. By remaining independent, the company doesn't encounter any pressure to change its tactics, he explains.

He points to the 10 months ended in March 2000, when the Nasdaq zoomed up 93% and the S&P gained 19%. In the same period, Dodge & Cox's equity fund actually lost 1%. "It's a simple approach in a way, but it's hard for people to sit there during that period and not change horses in the middle of the stream," he says.