After five years of mostly mediocre performance, Dodge & Cox's U.S.-oriented stock funds have emerged from the wilderness. Dodge & Cox Stock (symbol DODGX), a member of the Kiplinger 25, returned 20.8% over the past year, beating Standard & Poor's 500-stock index by 6.0 percentage points. And Dodge & Cox Balanced (DODBX) has turned in a similarly stellar run, gaining 17.5%. That topped the S&P 500 by 2.7 percentage points and the average fund in Morningstar's "moderate allocation" category by 6.5 points (all returns are through December 26).
Balanced, one of Dodge & Cox's five mutual funds, is essentially a sedate version of Stock. Balanced holds nearly all of the same issues as Stock in roughly the same proportions, but also invests a big chunk of its assets in the bonds held by Dodge & Cox Income (DODIX).
Lately, Balanced has been pushing the envelope when it comes to stock allocation, and that has helped performance. The typical balanced fund has 60% to 65% of its assets in stocks, and the rest in cash and bonds; but Balanced recently had 71% in stocks, near the maximum of 75% permitted by its charter. "Long term, the potential returns from fixed income are limited," says chief investment officer Charles Pohl. "We see significantly better long-term potential for equity."
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The strong 2012 is welcome news for Balanced shareholders, who have suffered through several years of mediocre performance. Compared with other funds in its category, Balanced was in roughly the bottom 10% in 2007 and 2008, and the bottom 30% in 2011.
When picking stocks, the San Francisco-based firm's 18 managers and 23 analysts favor growing companies at bargain prices and with enough financial strength to carry them through temporary problems. Says Pohl: "The impossible dream is to find something in a growth industry, with a dominant market share, a shareholder-oriented management team, and in an easy business to defend against new entrants -- and then buy the stock for some incredibly cheap price." The strategy doesn't always work -- witness Dodge & Cox's huge stake in the shares of Hewlett-Packard, which has turned out to be a value trip of the highest order.
Recently, Balanced's biggest stock-sector weightings were in financials, technology and health care. Balanced is overweight in drug stocks, despite a recent rash of patent losses. The rate of patent expirations is slowing, Pohl says, and the arrival of new drugs should boost the earnings of pharmaceutical companies.
Balanced's bond holdings account for a slim 23% of its portfolio. At last report, 38% of the bonds was in investment-grade corporate debt, and 25% was in government-agency mortgage securities. The average duration of the bond portfolio is 3.5 years, leaving it modestly vulnerable to rising interest rates. (A one-percentage-point rise in rates should cause the fund's bonds to decline about 3.5% in value.) But if rates rise because the economy is improving, Dodge & Cox's heavy allocation to stocks could still win the day.
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