What Went Wrong at Dodge & Cox?
The firm's intensive research failed to anticipate the implosion in financial stocks.
By Andrew Tanzer, Senior Associate Editor
From Kiplinger's Personal Finance magazine, February 2009
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In the sales-driven mutual fund world, there's a lot to like about Dodge & Cox, the sedate San Francisco fund manager. The firm keeps a low profile. It doesn't advertise, market products or chase fads.
Instead, its long-tenured managers focus on running just five low-cost funds. The managers and other Dodge & Cox employees own the firm and invest their wealth side by side with outside shareholders.
Over the years, D&C's disciplined and long-term-oriented investment process has handsomely rewarded loyal shareholders. For instance, during the 20 years through November 30, 2008, Dodge & Cox Stock (symbol DODGX returned an annualized 10.2%.
That was an average of two percentage points per year better than Standard & Poor's 500-stock index, an impressive feat, and good enough to land Stock among the top 10% of all funds, according to Morningstar.
Recently, though, Dodge & Cox has seemed almost accident-prone, and all of its funds have posted weak results. D&C Stock, for example, lost 46% in the first 11 months of 2008, seven points worse than even the execrable performance of the S&P 500 and a basket of large-company value funds.
Dodge & Cox Stock has been mired in slumps before. From 1995 through 1999, the fund trailed the S&P index by an average of seven points a year (by contrast, the fund beat the index by a resounding 11 points a year from 2000 through 2006).
But in many ways today's slump is more painful. Not only are the actual losses of wealth severe, but the money invested in financial companies that collapsed is gone for good. This sin of commission is much worse than its sin of omission (no sin at all, really) in the late 1990s, when D&C managers stuck to their value-investing principles and declined to chase Internet and other ridiculously frothy stocks at the height of America's epic stock-market bubble.
Measured Process
So what's gone wrong at Dodge & Cox, and can it and its funds rebound? Before conducting a postmortem of Dodge & Cox's disastrous foray into the minefield of financial stocks, let's review the firm's disciplined, research-intensive investment process.
Most investment ideas (and stock-sale decisions) percolate up from the firm's analysts and are then carefully weighed by various investment-policy committees, which consist of seasoned portfolio managers. It's a collegial, consensus-driven, bottom-up process.
D&C analysts and managers, says the firm's chairman, John Gunn, focus on financial measures, such as com-panies' sales, earnings, cash flows and dividends, as well as qualitative aspects, such as strength of business franchise and management. They assess growth prospects over five years (considering a range of outcomes and risks), look at the current stock price and decide whether to strike.
When Dodge & Cox people say they invest for the long term, they really mean it. Vice-president Diana Strandberg speaks of investing in stocks that can be locked up in a safe-deposit box for five years (an average holding period). "It's a tremendous advantage to have a long-term compass in periods of intense volatility," she says.
Over the years, the rigorous research efforts and long-term horizon have paid off. For instance, D&C Stock has reaped large gains over the long run in stocks such as FedEx, Hewlett-Packard and Wells Fargo. Clearly, the professionals at Dodge & Cox are thoughtful, patient and sober investors. So where did they come unstuck? Their main error was to gravely underestimate the risks in financial stocks -- such as American International Group, Fannie Mae and Wachovia -- that its funds loaded up on.
At the end of 2006, Stock actually held a below-average weighting in financial stocks: 14%, compared with the sector's 22% weighting in the S&P 500. After the subprime-mortgage and credit crisis began to erupt in mid 2007, financial stocks started to tumble. As prices of financial stocks plunged in the second half of 2007 and the first half of 2008, Dodge & Cox was buying. By June 2008, Stock was overweight in financials, with a 17% allocation, compared with 14% in the index. In the letter to Stock shareholders reporting on the second quarter of 2008, the managers wrote: "We have selectively expanded the Fund's financials weighting because in our opinion their valuations have declined more than their underlying long-term fundamentals have deteriorated."
Just a few months later, the roof caved in on financial stocks.
Reader Comments (22)
Posted by: SteveTheHawk at 01/08/2009 09:12:04 AM
I agree that Dodge & Cox needs to re-evaluate how they choose stocks. There was a time I was impressed with them, but no longer. I used to hold about 20% of my 401K in DODGX. Over a year ago I started moving money out in that I was bit concerned about the fund and their holdings. I'm now down to about 3%. Probably should have just taken it to zero, but whatever. I am making regular but very small contributions again but will call that good for now. I'm not in any hurry to jump back into the fund.
Posted by: Jack S at 01/08/2009 12:51:08 PM
One year ago I closed my IRA and regular accounts with Dodge and Cox. They did not calculate my IRA distribution correctly. I brought this to their attention and they were not helpful (arrogant). I informed the management of this event. They apologized and appeared sincere, but I felt that it represented an organizational problem with D&C and closed my accounts.
Posted by: rahul shah at 01/08/2009 04:38:09 PM
I almost threw up after reading the article. I joined DODGX last year when they opened, not realizing the dogs in the portfolio. What on earth would make somebody buy GM or Ford stock last year? Just because it was cheap? Is that a good ennough reason, especially knowing GM is the dog of dogs as a stock investment. I am glad I just put in the $3000 minimum, and even more glad, that my larger investment is in FPA. A CHEAP STOCK DOES NOT A GOOD STOCK MAKE - amazing that a roomful of Stanford and Harvard MBAs didn't figure out..I too have an MBA, and look at the macro economy long enough to determine if an investment will be a dog. I've lost 40% of my $ 3000 - and no, I WILL NOT INVEST AGAIN with these hot shots. CHEAP is not equal to VALUE. Bill Miller too found out the hard way...
Posted by: Riverrat at 01/09/2009 06:45:03 AM
The problem, dear Dodge & Cox, lies not in the government, but in yourselves.
Posted by: CBG at 01/09/2009 12:36:42 PM
I found your article weakly supportive for this company. Regarding the managers' investments in the funds, exactly what does "heavily invested" mean? I would strongly suggest that these "competitive and serious high achievers" sit down and reflect on how their decisions have impacted their investors especially the ones who have had to withdraw an IRA Required Minimum Distribution in 2008. Sadly, I have to hold on now and hope to recoup the losses in the Balanced Fund that I counted on to stabilize my portfolio in any downturn in the markets.
Posted by: Steve R at 01/09/2009 04:17:11 PM
My financial "advisor" recommended and invested nearly my entire portfolio in Dodge & Cox. After losing over 40% of its total value I instructed him to move everything into the money market in mid Nov. Consequently, Nov-Dec '08 was the first month in many that I didn't sustain 5-figure losses. I don't know about reinvesting with Dodge and Cox but I do know I'll be looking for a real financial advisor. As I am currently 57 years old, I doubt that I'll ever have enough money to retire after this financial debacle.
Posted by: JR Cash at 01/09/2009 04:43:54 PM
Rahul: You somehow failed to see the "dogs" in the portfolio last year?! Hello, wasn't Citi was a top-5 holding, there for all to see? Believe that was the case...I've been in D/C Stock for about 10 years, and will remain there, albeit with a minimal investment. Very very glad to have stood pat when I thought they were cheap in the low 100s! I'll probably start building up a position again, as I think Gunn can handle this screw up as well as anyone can.
Posted by: Mike at 01/10/2009 10:52:05 AM
Many, many years ago, the D&C Balanced Fund's prospectus stated that no stock investment would exceed 2% of total assets; that provision was dropped at some point. A couple of years ago, D&C lowered the minimum bond quality for the Balanced fund. I should have known when these things happened that it was time to move on 100% into Vanguard Wellington Fund. A wealthy and low profile close friend recently commented that asset management absolutely requires broadly diverse academic training and equally diverse personality types. One of the best arguments of indexers, in my opinion, is that investment obectives and styles do not drift. I just cannot bring myself to invest again with D&C. Peace.
Posted by: RKay at 01/11/2009 07:01:28 PM
The events of the past five months show that when it comes to finance, no amount of experience or education helped. Other than a few contra-thinkers who perhaps got lucky, lots of "high achievers" turned suckers. Moral - Don't trust ANYONE with your money - that includes your financial advisor, Kiplinger etc. My opinion is that you should diversify - not just with sectors - but between managed funds and index-driven ones (ETFs) for your chosen categories.
Posted by: Weiwen Ng at 01/12/2009 06:00:30 PM
I, too, am thinking that D&C will be able to outperform in the future. The article didn't mention Dodge and Cox Income (DODIX), a conservative and very cheap bond fund. They have about a 1/3 stake in high quality corporates, which I believe have sold off unreasonably. They have about 45% of the fund in agency bonds, which are now backed by the government. This seems like a pretty safe bet for a rebound.
Posted by: Joe F at 01/21/2009 08:48:28 PM
There's a mantra in the investment world, buy and reassess your facts and analysis. It is obvious that D&C has basked in their own historical performance a little too often and far too long. One of the items that the article didn't mention is that did a key portfolio manager, analyst or other staff member leave, quit, or retire over the past 5-7 years?? It is obvious that they now have a swashbuckling mentality that is not consistent with their historical investment approach. Something HAS changed, and its not just that the performance is terrible. It is likely that a key analyst or person who played devil's advocate on the stock picking committee is no longer there to test the hypothesis before purchase. I am equally shocked that this reporter believed in their excuses rather than exploring further about what has changed with the culture or staff. As a holder of two D&C funds, I am growing disheartened...--- and even worse, they seem to have doubled down recently. To the author of the article, if you are truly interested in asking "what went wrong", then please ask the correct questions -- and don't believe the b.s. that they might try to feed you the first time. Myself, we will be reconsidering D&C as one of our 401k options -- and likely removing the company as a provider, for all our employees. BTW -- is the SSGA prime money market fund one of the funds that broke the buck at State Street? Are they involved in any of the securities lending losses at State Street?
Posted by: Charles L at 02/13/2009 08:02:09 AM
I too am reconsidering my substantial investments in both the stock and international funds of dodge and cox. In making the decision to participate in an actively managed fund I had assumed there was LESS downside risk because I was employing a fund manager who would SELL stocks in a company in free fall - therefore NOT carrying myself, my wife, and all of the other customers down with the ship. I never would have invested in Dodge & Cox if I had known the manager would simply sit and watch as Rome burned.
Posted by: THE COWBOY at 02/23/2009 05:24:11 PM
I have owned these funds for twenty years with good returns. But I must say at this point that anyone who is willing to pay ANY fee at all for this kind of performance is insane. As one of the responders wrote it is unbelievable that they just sat there and let this kind of damage happen unabated. One of the cardinal rules of stock trading is to never, ever take more than an 8 per cent loss. Have none of these Ivy league types ever heard of selling? One thing that I know without a doubt after thirty years on Wall St. is that the greatest weakness of all mutual funds is that they would rather have a brain aneurysm than sell a share of stock no matter what is happening. We all believed the old mantra that stocks can't be actively traded and that traders never go home rich. What malarkey! I can tell you now that every active trader I know was well and truly gone long before this shipwreck happened. An 8 per cent loss would look pretty good right now, wouldn't it?
Posted by: jack at 02/24/2009 12:45:21 PM
My wife an I have shared 457 plans with 3600 shares of international fund and are deeply concerned with the way the fund has lost value. We are less than 4 years from retirement, and we are currently down $86,000. I would have thought that D&C would put some type of acknowledgment on their web page of how they are trying to restore value, but nothing. What's up?
Posted by: WayneG at 03/04/2009 10:05:45 PM
I invested almost everything in the four Dodge and Cox Funds five years ago after I compared their performance against Fidelity through the .com bust. Through 2007, I was absolutely convinced I was on board a cash machine with world class management. I recommended these funds to friends and relatives. What happened to all the D&C funds in 2008? A loss of over 40% in all funds except Income and 2009 is starting off with a continuation of the same dismal performance. I'm out $90K of IRA money that I need in less than a decade. I'm just a little concerned that D&C needs about seven years of 10% growth just to get me back to where I was two years ago. Time is not on my side. My annual contributions now go to Fairhome and Oakmark, both of whom weathered this storm much better than the Dodge and Cox team. I can't believe that management would practice buy and hold when it was pretty obvious a year ago that BIG problems were on the horizon. Hope they figure out what to do with what's left of my retirement soon or I'll be working at Walmart in 2018.
Posted by: Bostonrunner at 03/12/2009 06:28:27 PM
One would be hard pressed to find any stock fund that avoided the recent downturn. Both domestic and international funds suffered and D and C stock fund and international fund took a hit, just like all the others. Now that things are bottoming out, the real question is stated by Kiplinger - will they move forward and beyond their miscues? This is true for all the other stock funds too. What is more difficult to determine will be which is the best fund to be in during the recovery? The best way to gauge this will be to look at how funds recovered from previous downturns. Unfortunately, there is no track record for what we have recently experienced. Caveat emptor applies now more than ever.
Posted by: Got Smarter at 05/26/2009 05:15:24 PM
American Funds, Vanguard, Fidelity, etc. We all lost in this one! Retirement for most, is all but a ...dream!
Posted by: daughter of winner at 05/29/2009 10:56:03 AM
How smart was my dad when 2 years before he died (Spring 2007) he cashed out all his investments so upon his death there was quite a legacy.
Posted by: AK DJ at 06/30/2009 05:25:33 PM
We lost several hundred thousand dollars in D&C, but will keep buying and hoping for the best. Still have 20 years before retiring, got to take the downs to enjoy the ups!
Posted by: Fred Kinner at 07/17/2009 03:11:05 AM
Very disappointed in Mr Gunn's "blame game". Blame the Gov, blame Stanford and Harvard, blame left brained analysts, Blame left handed poeple!!...
Posted by: Edward Dijeau at 10/06/2009 10:36:04 PM
Dodge and Cox continues to outperform the S&P. It has rebounded faster than the S&P and you only lost money if you cashed out. A paper loss will again turn into a paper gain, but, a cashed out loss is forever. My pension plans, in Dodge and Cox Balanced fund, for 42 years, allowed me to retire at age 55 and since I did not cash out, I did not suffer a large loss. In fact, instead of having a 8000% gain on my pension draw, I only had a 4800% gain during those draw months, if you use first in first out accounting. The balanced fund re-balanced buying the next big winners so the team is still working for me. Thank you Dodge and Cox.
Posted by: Ben at 11/07/2009 03:25:19 PM
I love reading back over these early comments now. I understand that some people lost a bunch of money with D&C earlier this year (who didn't lose money!?) and all they can do is complain and complain. NOW, look at D&Cs performance. Bravo to the folks who stayed, and shame on those who let the worst financial crisis in 70s jade their opinion. Perhaps the attitude HAS changed there (there are perhaps only a select few who true holdovers from the mid nineties are still there) but still, the crazy complainers from earlier this year look like some pretty sore losers. Their haughty and arrogant complaints, thinking they could do better, look pretty dumb now. HA!