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Pohl: Equities Still Look More Attractive Than Bonds

Allocation manager of the year winner Charles Pohl of Dodge & Cox says rising rates and high valuations are the key tenets of his cautious outlook.


Andrew Daniels: Hi there, I'm Andrew Daniels for Morningstar. Today, I'm joined by Charles Pohl from Dodge & Cox. Charles is representing the Investment Policy Committee from Dodge & Cox Balanced, which won the allocation and alternatives fund manager of the year award for 2016. 

Charles, congratulations, and thanks for being here today.

Charles Pohl: Thank you. Glad to be here.

Daniels: 2016 was an outstanding year for the fund all across the board. So could you elaborate just a little bit on what specifically drove results?

Pohl: Well, it was a combination of things. One was that the equity portion of the portfolio did very well. That was especially helped by an overweight position in financials. We also had an asset allocation that was more tilted toward equities and away from fixed income, and that contributed to the fund's results. And the fixed-income performance was relatively good and helped somewhat by having a shorter duration than many others.

Daniels: In the technology space, you have owned both, now split, HP and Hewlett-Packard Enterprises. What led to that decision in late 2015 to hold on to both companies, post-split?

Pohl: Well, I think that Hewlett-Packard in general, the whole entity, coming up into the split has been far better managed under Meg Whitman than it was previously. And she's shown a real commitment to trying to develop long-term shareholder value. The franchises underlying some of the businesses are very strong and the multiples are very low and then by splitting the company, they allowed for a higher level of focus on the individual businesses. So taking printers away from the rest of the business, they created a much more focused enterprise. Our experience has been when management served more focus in their business, they tend to be more successful. 

The two pieces were trading at a very low valuation as well, and then it's very interesting what she's been able to do on the HP Enterprise side with the deal with their services businesses with the computer sciences, which we think will be very enhancing to the shareholder value. Then more recently with the software deal with Micro Focus, and she's just continued to find ways to try to enhance the focus of the company and improve shareholder value.

Daniels: You mentioned before the shorter duration position benefit of the fund in 2016, but that's been kind of a longer-term strategic move for the fund. Have there been any recent changes to that shorter duration position?

Pohl: No, there haven't really. When you look at interest rates in a long-term perspective, they've been declining since 1981 and they are at exceptionally low levels, even though they've rallied about 100 basis points since June, the 10-year Treasury has. They're still at extraordinarily low levels relative to history, and we see signs that inflation is picking up, unemployment is getting quite low and so there are wage pressures potentially. Then also, you have to wonder if there is a big stimulus bill, what that might do in terms of putting upward pressure on interest rates. And so we see a lot of risks to having a longer duration right now.

Daniels: That is also factored in the decision to be more overweight equities?

Pohl: Yes, it has because it's hard at these levels of rates and at these levels of spreads to pencil out strong returns from a fixed-income portfolio. The equity market obviously has gotten more expensive, and so we're a little more cautious about that, but when you look at the alternative bond portfolios, you're likely to have low returns coming out of there and maybe even negative real returns when you factor in the fact that inflation seems to be on the uptrend.

Daniels: Looking ahead to 2017, and perhaps since you are so long-term focused, many years beyond that, how are you positioned in the portfolio currently, to as you consider what potential policy changes might be occurring in Washington, and more broadly, just how are you positioned in the portfolio currently?

Pohl: Well, we continue to believe that the financials will do well. They benefit from and will benefit from an emphasis on deregulation that Trump has publicized. Also from a higher interest rates, they're clearly beneficiaries of that and so we still feel good about that overweight. We're overweighted in the healthcare area, which performed very poorly in 2016, but that creates more attractive valuations and we're also very interested in some of the emerging developments in the immuno-oncology area. There's some exciting stuff going on there in the battle against cancer. So we see opportunities in both of those. 

The asset allocation, you posed this dilemma in that we don't think that the returns from fixed income are going to be very strong going forward given how lower rates are as the starting point, but also as the equity market gets higher and higher, you want to become a little more conservative about equities. I think the net is that you'll see us adopt a little bit more conservative asset allocation position going forward.

Daniels: Great. Well, Charles Pohl from Dodge & Cox, thank you for being here today and congratulations again on the award.

Pohl: Thanks for having me.

Daniels: For Morningstar, I'm Andrew Daniels. Thanks for watching.

Andrew Daniels does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.