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In its 76-year history, Dodge & Cox has launched precisely four mutual funds. The firm doesn't advertise and has no marketing department. Yet investors are so taken with its funds that it has had to shut half of its tiny lineup to new customers to stanch the flood of money.
Obviously, results attract customers, and Dodge & Cox's results have been marvelous. D&C Stock, the biggest fund, with assets of $57 billion, has clipped Standard & Poor's 500-stock index seven straight years (including the first eight months of 2006). Over the past 15 years, its annual return of 15% tops the S&P 500 by an average of four percentage points per year. D&C Income, which invests mostly in high-quality, medium-term taxable bonds, has outpaced its average peer in 16 of the past 17 years. Balanced, the oldest fund, dating to 1931, has been in the top 20% of similar funds in each of the past six years. And International has surpassed its average rival in each of its five years of existence. (International and Income are the only funds that are open to new customers.)
What's behind the success of Dodge & Cox? Its funds are helped by remarkably low fees. Staff turnover is almost nonexistent -- another plus. And the firm's unrelenting focus on buying undervalued stocks and bonds is legendary. But what sets the firm apart from most mutual fund shops is its method of picking stocks and bonds: Before a security is added to one of the funds, it must be vetted by one of three committees.
To peer behind the curtain, we chatted in San Francisco with the firm's president, John Gunn, a 34-year veteran who is the firm's chief executive and chief investment officer, and Diana Strandberg, who joined in 1988 and who, like Gunn, is on the committees that oversee the three stock funds.
KIPLINGER'S: What's the key to your success? Is it those fuddy-duddy investment-policy committees?
GUNN: We started as a firm to manage an individual's entire wealth. We try to preserve and enhance the client's wealth over a four- to five-year time horizon. And the first principle that comes out of that is a sort of investors' Hippocratic oath: Do no harm. As for stock picking specifically, we ask ourselves, Do we want to become a part owner of a company looking out four or five years?
But don't other fund companies follow the same principles?
GUNN: We look at the longer-term earnings prospects, but we also focus on valuation. The two are joined at the hip. Let's go back to 2000. The megacap stocks -- those with market capitalizations of roughly $100 billion or more -- were about 33% of the S&P 500 and we basically had zero in those stocks. From a valuation perspective, about 25% of the market sold at roughly 15 times sales and 85 times trailing earnings, and we had nothing in those stocks. Another 37% or 38% of the market sold at 3.5 times sales and 30 times earnings, and we had about 9% of assets in the lower-value part of those stocks. So, in the middle of the biggest, wildest speculation ever, almost all of our holdings were in the remaining third or so of the market -- mostly in "old economy" stocks selling at about 80% of revenues, and one-third in financial stocks selling at about 13 times earnings.
You're certainly not closet indexers.
GUNN: We also don't have a momentum bone in our body. We believe that previous share-price activity has nothing to do with future price activity.
Do you assemble your portfolios stock by stock? Or do you make calls on the big picture?
GUNN: We look at long-term forces that we think are pushing the global economy in a certain direction at a certain speed. We believe that the two biggest forces -- things that have been going on for many years now -- are rapid technological innovation, especially in communications, and growth of the developing world. The end of the Cold War has allowed more and more of the world's population to participate in free-market economies, to see how the other half lives, to produce and consume more.
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