Dan Culloton: Another thing that investors who look at the fund right now might be perhaps alarmed by is seeing the very large position, a relatively large position in California municipal bonds, given all of the consternation that there has been in the media over state finances, and in particular, municipal bonds in general. How do you get comfortable with making the California position and other municipal bond positions in a taxable portfolio, such a large portion of that portfolio?
Tom Dugan: First thing we do, whenever we're considering any investment for the fund, is do the very thorough research, and that can be on a corporate issuer, that can be on a specific type of mortgage-backed security.
In this case, the Build America Bonds program enabled municipalities to sell securities at very attractive yields for investors like the Dodge & Cox Income Fund.
So, our research there was to basically try to understand everything we could about the State of California, the ability to assess taxes. So, we went through a very typical, very thorough research process, and feel like there is a lot there in California; it's an asset-rich, economically vibrant state with a huge set of assets.
Obviously, the economic situation right now in California is not a super-strong, [just like] in most of the country, but we think the economy can rebound. We think when it does rebound, state revenues will rebound, and a lot of the headlines that one is reading about budget deficits will start to ease over time.
Another factor in this is simply that budgeting at the state level is a year-to-year process, and every year, basically, the state has to make it square. It has to figure out a way to have its outlays equal its revenues, and there is a certain discipline to that. It's not a pretty process to observe politically. There is an extraordinary amount of noise associated with that, but there is a real discipline to that process, and we've been two or three years into this with the State of California. Every year it's noisy, every year a budget eventually gets resolved, and they find themselves in a position to be able to pay the debt service of their bonds.
So, we're comfortable. It's a situation we continue to monitor. It's going to be a situation that's going to be in the headlines for some time. The issues associated with state and municipal finances aren't going to go away anytime soon. There are issues associated with long-term liabilities like public employee pensions. These are going to take a long time to figure out.
But at the end of the day, we're comfortable with the position; the position is about 3% of the fund. We don't think it's too outsized, but it is a significant weighting, and we're very confident. And we think that the valuation associated with this investment is quite compelling given the risks and, ultimately, the ability of the State of California to levy taxes in such a way as to be able to provide services and pay back debtholders.