Today No-Load Fund Investor Editor Mark Salzinger revisits an old favorite balanced fund that’s appropriate for all types of investors in an extended recommendation.
Dodge & Cox Balanced Fund (DODBX)
Isn’t it time to forgive Dodge & Cox?
For decades prior to the financial crisis and bear market, superior investment performance and very low expense ratios had enabled the firm to become one of the most respected managers of actively managed funds. However, the 73-year-old firm lost considerable luster during the financial crisis, when its flagship fund Stock (DODGX) lost approximately 60% of its value from peak to trough, and even its blended fund Balanced (DODBX) lost about 45%.
Performance during the rebound has been very strong, however. From March 2009 through June 2013, Stock, Global Stock (DODWX) and International (DODFX) produced total returns of 162%, 163% and 129%, respectively, while Balanced gained 124%. During the same period, the S&P 500 gained 140%, while the Morgan Stanley EAFE Index of developed foreign market equities gained 88%.
Before and during the financial crisis, Dodge & Cox underestimated the carnage that was to be inflicted on the financial services holdings within its equity-oriented funds. A relatively traditional value investor, it was attracted to the below-average valuations of such stocks, which it likely saw as an investment anomaly and overreaction, as opposed to a discount justified by complex, huge and risky exposures to the lower-quality strata of the mortgage market.
However, over longer investment horizons, the Dodge & Cox investment approach is likely to continue succeeding. Investment ideas for the firm’s equity-oriented funds originate with internal analysts and are debated by investment committees comprising multiple investment professionals, who have practiced their profession at the firm for many years, even decades. The firm compares its own analytical judgments with those of outside analysts (looking for stocks in which it has more confidence), and seeks to invest in stocks with considerable baked-in pessimism—especially in companies with the financial strength to sustain themselves through significant short-term difficulties.
Dodge & Cox invests with a contrarian mindset. Consequently, it sometimes invests in stocks that end up going lower until conditions improve and results turn up. As a result, the equity portfolios tend to be more volatile than the broad market, and too many of their shareholders lack the stomachs to hold on long enough to experience above-average gains.
Portfolio turnover within the equity portfolios is exceptionally low: less than 20% most years. The managers attempt to look out three, five, 10 or even more years and decide if the company is very inexpensive at its current valuations, given the nature of its business, the durability of its franchise (i.e., competitive advantages), and the quality of its management.
All of these factors taken together are why most investors should give the greatest consideration to Dodge & Cox Balanced (DODBX). Though this fund is more aggressive than most other balanced funds, its fixed income component should smooth out returns enough to make it the best choice for moderate investors who want Dodge & Cox to be in charge of some of their money.
Stocks account for up to three quarters of Balanced, while investment-grade bonds make up the remainder. (On average, balanced funds have a stock/bond split of 60/40.) As of June 30, the weighting in stocks was approaching the upward limit. The fund included 71 stocks, with a median market capitalization of $24 billion—the lower end of large cap.
On a 12-month forward basis, the equity portion’s price/earnings ratio was 12.4, which is considerably lower than that of the broad market. The financial services and technology sectors accounted for about 17% of the fund each, while healthcare and consumer discretionary were also significant. No other sector was more than 5.4% of the fund. Foreign stocks accounted for 11.4% of assets.
Most of the fund’s top holdings are large, well-known companies, a few of which have experienced deep nicks in recent years but have recovered recently (e.g., Hewlett-Packard and Wells Fargo). Many of the stocks with smaller weightings are less renowned and have yet to rebound from investor disdain. So, despite a 25%-plus gain over the past 12 months (among the very best within our Hybrid category), the fund has considerable fuel to continue rising if even more of its contrarian picks pan out.
Corporate and mortgage-related bonds account for about 80% of the fund’s bond assets. In terms of credit quality, the bond portion is approximately halved between ‘Aaa’ rated debt on the one hand and lower-quality investment-grade debt (‘A’ and ‘Baa’) on the other. The bond portion included nearly 300 disparate holdings at the end of June, with an effective duration of 4.2 years. So, volatility in the bond portfolio should be moderate in the face of changes in interest rates.
Compared to the S&P 500, Balanced has been about 11% less volatile over the past three years. The fund’s minuscule expense ratio of 0.53% adds to its appeal, as does its minimum initial investment of just $2,500.
Mark Salzinger, The No-Load Fund Investor, www.noloadfundinvestor.com, 800-706-6364, August 2013