Special Report
The following is an excerpt from Morningstar's Premium Analyst Report for Dodge & Cox Income (DODIX), an intermediate-term bond fund that receives a Gold Morningstar Analyst Rating. Morningstar.com Premium Members can click here to see the full Analyst Report. Not a Premium Member? Take a free Premium trial to gain access to this and hundreds more reports.
Process Pillar: Positive | 10/28/2013
The fund's managers know what they're good at, and they stick to it. They invest with a three- to five-year investment horizon in mind, balancing the goal of outperforming the Barclays US Aggregate Bond Index with minimizing the risk of loss over that stretch.
The managers view income as an important driver of long-term returns, so they aim to assemble a portfolio that delivers more yield than the index. That has often resulted in overweightings to agency mortgages and corporates, as well as a 10%-plus stake in high-yield debt at times. The fund's corporate stake is where much of its risk resides. The managers concentrate that corporate exposure in around 50 issuers. They're not afraid to hold bonds that have courted controversy, such as junk-rated HCA Holdings (HCA) and Ally Financial (ALLY), but idiosyncratic risk is limited by position sizes that typically run at less than 2.5% of the portfolio.
That corporate emphasis plays to the strengths of the firm's extensive industry research resources. An often-sizable stake in U.S. government-backed agency mortgages also counterbalances the fund's credit risk. The team doesn't get fancy with more esoteric structured products or currency plays employed by some competitors, though the managers did begin using a modest amount of Treasury futures to manage the fund's duration last year, and they employed TBA mortgage forwards in mid-2010.
Several of this fund's long-standing biases have become even more pronounced over the years. The fund's managers kept its duration shorter than its Barclays Aggregate US Bond Index's (usually by around 10%-20%) for nearly all of the past decade, out of concern that rising yields could eat into shareholders' capital. Yields have instead dropped for most of the period, but the team was no less concerned: The fund's duration stood at 3.7 years going into 2012. That proved a positive as rates spiked in mid-2013. Citing more attractive valuations, the managers upped the fund's duration modestly during the year, to 4.4 years as of September 2013, still short of its index's 5.5 years.
The managers also lowered the fund's exposure to Treasuries, even as their representation in the index ballooned to 36% from 22% in January 2008. As of September 2013 the fund's Treasury stake stood at just 3.3%. Meanwhile, the team modestly increased the fund's position in mortgage-backed securities to 34%, a slight overweighting relative to its index (30%).
The fund's credit exposure--including a 6% stake in taxable munis--has comprised roughly half its assets since early 2009. The managers have emphasized banks within the corporate stake (10% of assets), mainly large money centers like Bank of America BAC, as banking-sector yield spreads have remained wider than historic norms since the financial crisis.
Performance Pillar: Positive | 10/28/2013
This fund's long-term record stands out. Its average annual gain of 5.1% over the past decade ended Oct. 22, 2013, tops the Barclays US Aggregate Bond Index by 46 basis points per year and tops 75% of its intermediate-term bond peers. The fund has stayed competitive over shorter periods, too. Its 0.3% loss lagged the index by 550 basis points in 2008's credit downturn, but it still held up better than roughly two thirds of its rivals. What's more, additions to the battered corporate sector helped the fund to a 16.1% gain in 2009, outgunning 70% of the pack during that year's rebound.
With about half its portfolio in corporates, and a defensive interest-rate posture, the fund has looked less and less like its increasingly Treasury-heavy index in recent years. That distinct profile, in addition to its concentrated exposure to individual corporate issuers, including high-yield and volatile banking sector debt, was a positive through the first nine months of 2013 as interest-rates spiked. It could cause the fund to lag its typical peer and index when macroeconomic concerns afflict the market, though, as was the case in 2011. The team took advantage of that year's third-quarter's slump to add to the fund's holdings in the financials sector, giving it an edge in 2012 and into 2013. By moving early, deliberately, and with an awareness of its risks, the fund should continue to reward over time.
People Pillar: Positive | 10/28/2013
The fund's 10-member investment policy committee, or IPC, is a seasoned group. Its members have between 10 and 30 years of investing experience, and all have spent the bulk of their careers at Dodge & Cox.
A group of 32 industry and regional analysts supports both the stock and bond managers' efforts. The team argues that cross-pollination comes in handy, since company management's intent on increasing shareholder value through dividends, share buybacks, or acquisitions don't necessarily have bondholders' best interests in mind. Addressing both audiences at once helps keep companies honest. As of Sept. 30, 2013, roughly 20 of this fund's corporate issuers were also held in the firm's equity portfolios.
The firm's equity and bond efforts still compete for the industry analysts' time, however. To ensure that this fund covers all its bases, a group of 12 corporate bond generalists (including a few IPC members) focus on the nuances of the corporate debt markets, conducting additional downside analysis and assessing individual securities' structure and covenants.
The fund's corporate stake has the most potential to punish as well as reward, so it makes sense for the team to tilt its resources in that direction. However, another experienced group of 12 individuals helps run the fund's agency mortgage, government, asset-backed, and taxable muni stakes.
Parent Pillar: Positive | 10/31/2013
Employee-owned Dodge & Cox is an exemplary firm. CEO and president Dana Emery and chairman Charles Pohl are also lead members of the investment team, and they run both the firm and its funds with a long time horizon. The average fund manager tenure of almost 23 years is exceeded by only a few companies, and the firm's five-year manager-retention rate is 98%.
There are no stars here; each fund is run collaboratively by an investment policy committee. Ideas can come from anyone but must survive peer review to get into the portfolios. Although the funds have seen outflows in recent years, the firm has continued to build the investment team at a slow-and-steady clip. It now totals more than 55 managers and analysts.
Dodge & Cox has rolled out only five funds since it first opened in 1931. As a natural extension of its international-equity expertise, it is now developing its global-bond capabilities. Since 2009, three of the funds have become available overseas. While the firm has eschewed marketing, it is among the largest mutual fund companies today. Asset growth can hinder execution, but management has proved willing in the past to safeguard its strategies by closing funds.
Managers are heavily invested in the funds and the firm and have ample incentive to serve shareholders, evinced in low costs, clear communications, and a sober long-term approach.
Price Pillar: Positive | 10/28/2013
The fund's 0.43% annual expense ratio makes it one of the cheaper options available to no-load investors and represents a significant savings compared with the 0.68% levy charged by the median no-load intermediate-term bond fund. Considering that the fund's expense ratio has hardly budged as its assets have roughly doubled over the past five years, there's arguably room for it to come down further. Relative to other options, however, there's very little cause for complaint.