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Dodge & Cox Has Faced It All and Stood Tall

Mistakes? This family has made a few, but it has done it its way.

Dan Culloton, 09/13/2010

Long-term investors run Dodge & Cox for long-term investors. That fact remains, even after recent executive changes and bouts of poor short-term performance.

The firm is going through another succession at the top but has a wealth of experienced people on which to draw. John Gunn, 66, who replaced the retiring Harry Hagey as chairman in 2007, will become chairman emeritus March 31, 2011. Ken Olivier, 58, who has been with the firm for more than three decades and was named CEO in March 2010, will succeed Gunn. At that time, fixed-income director and executive vice president Dana M. Emery, 48, and CIO and senior vice president Charles F. Pohl, 52, will become co-presidents.

There are more experienced people advancing up the ranks after Emery and Pohl. The median tenure of the firm's equity and fixed-income analysts and managers is more than 10 years. The median years of service to the firm among members of the organization's investment policy committees, which comprise much of the fund family's senior leaders, ranges from 17 to 25 years.

More importantly, all of the top executives began their careers as analysts or managers at the firm and are still involved in the investment process. Just as they invest with a three- to five-year time frame in mind, they take a long-term view in running their business, planning transitions several years in advance and keeping their clients' interests in mind.

A key to Dodge & Cox's success has been its ability to attract and retain qualified people who share the same investing temperament and ability to work as part of a team. The firm has one of the highest five-year manager-retention rates in the mutual fund industry, Morningstar data show. Because of its strong reputation and track record, the firm has been able to increase its staff over the years with minimal recruiting. Even in the throes of the financial crisis and bear market of 2007-09, when the firm's funds suffered outflows and lousy performance, it was able to attract and keep people. It has kept hiring one or two new graduates a year from top business schools such as Stanford, University of Chicago, and Harvard, and then has given newcomers time to imbibe the firm's approach and ethos. Investment personnel can be invited to become owners after about four or five years. Their equity, which partners buy and sell at book value (which is based on firm revenue and profits and is independently calculated and audited by PricewaterhouseCoopers), can become a big portion of their compensation and incentive to stick around.

No firm keeps everybody. As Dodge & Cox has grown, people have been able to make more money faster. Some of them might feel secure enough to break off on their own. It has happened at least once--when Kouji Yamada, a veteran analyst and manager of Dodge & Cox International Stock DODFX, left in 2007 to start his own firm. But even if Dodge & Cox's employee turnover increases in the future, it's still likely to be below average.

Dodge & Cox has learned that it will do well if its clients do well. The firm was founded near the beginning of the Great Depression. Patience is ingrained in the firm's culture. Its regulatory disclosures and shareholder communications are clear and consistent. For instance, even before Dodge & Cox Stock DODGX, Dodge & Cox Balanced DODBX, and Dodge & Cox Income DODIX slipped into slumps in 2007, the funds' managers cautioned investors against believing that the offerings' previous decade of strong absolute and relative returns could continue uninterrupted. That didn't prevent some shareholders from feeling angry and frustrated with the shop's travails, but at least the firm tried to manage expectations.PAGEBREAK

Likewise, many investors found the firm's October 2008 market commentary published in the throes of the financial-market meltdown to be cold comfort. The missive acknowledged that 2008, the worst calendar year ever for its stock funds in absolute terms, was a difficult year and that, as fellow fund shareholders, the managers felt investors' pain. But the letter lacked a mea culpa for owning stocks such as American International Group AIG, Wachovia, and Fannie Mae that the government either took over or forced into the arms of rivals at catastrophic discounts. Granted, in such an environment there was little the firm could have written to assuage everyone's angst, yet it seemed to point the finger more at the government than at itself.

Behind the scenes, however, Dodge & Cox managers did a lot of soul-searching and process- and portfolio-vetting. The firm redoubled efforts to analyze companies' short-term liquidity needs and started paying more attention to Washington, D.C. In the face of intense pressure, though, the firm stuck with the process that had served it and its clients for 80 years. That approach, while value-oriented and contrarian, doesn't rely on any one set of measures or screens but rather is built on patient and thorough bottom-up research of individual companies to determine if their businesses look strong enough and their shares cheap enough on a variety of metrics to hold for at least three to five years. Dodge & Cox doesn't lean on any one person either. Analysts and managers work as a team; anyone can advocate an idea, but they have to win over, or at least answer the objections of, their peers before getting it in any of the portfolios. A team approach can lead to group-think or paralysis, but over the decades Dodge & Cox has refined its team method into an effective tool.

While Dodge & Cox's equity funds have yet to make back all of what they lost in the 2007-09 bear market, they have outperformed their peers and benchmarks since the crisis' March 2009 nadir. As stated in a November 2008 Morningstar case study, if there is a firm that can emerge stronger from a period of distress, it's Dodge & Cox.

There are other reasons to trust the firm. It shuns marketing and advertising, has no salespeople, and has rolled out just five funds in eight decades. The last time it introduced a new fund--Dodge & Cox Global Stock DODWX in 2008--the firm waited several years to prepare and test it before launching it with very low expenses. The firm has begun to offer its services in Europe but is doing so in a measured fashion. The firm has opened one small shareholder-servicing office in London and is offering a single fund--a version of Dodge & Cox Global--priced significantly below average on the continent.

Against the Flow
That client-focused, squeaky-clean image and long track record attracted scores of new investors and about $100 billion in inflows from 2000 to 2007. Although those inflows turned to $12.5 billion in outflows in 2008 and 2009 (it's gotten about $2 billion in inflows so far this year, mostly into its Income fund) as the firm's funds stumbled, size still presents a challenge. Dodge & Cox, however, has been willing to put shareholders' interests above business considerations. It closed its Stock and Balanced funds to new investors for four years from 2004 to 2008, a period during which it could have touted its strong performance to reel in shoals of new shareholders.

Dodge & Cox funds' Morningstar Investor Returns, which measure how the offerings' typical investors have done by including the impact of cash inflows and outflows in the total return calculation, have deteriorated in recent years. Investors who dumped the equity funds in the midst of the crisis missed their subsequent rebounds and diminished their results. The average dollar in Dodge & Cox International Stock, for example, lost more than 4% annualized in the five years ended August 2010 while the fund gained 2.9% annualized on a time-weighted basis. One could argue the firm could have done more to manage its shareholders' expectations, but that would be like blaming the theater owner for patrons screaming fire in a crowded auditorium. There's only so much you can do in the face of a panic.

Panic is not in Dodge & Cox's vocabulary. Over 80 years it has seen depressions and expansions, bear and bull markets, high and low interest rates, inflation and deflation, war and peace, inflows and outflows, natural and man-made calamities, and mistakes and successes. Through it all, the family has amassed a vast store of institutional memory that has helped it keep its head in both exuberant and frightening times and stay focused on the long-term interests of its clients. The firm is not above making mistakes, but it's a cut above other fund firms culturally.

Dan Culloton is an associate director of fund analysis for Morningstar.

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