A Bond Fund With a Strong Pedigree Earns an Upgrade

The following is our latest Fund Analyst Report for Dodge & Cox Global Bond DODLX . Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

Dodge & Cox Global Bond, which lands in the revamped world bond Morningstar Category, was launched in 2014. It is built on the same foundations featured in Dodge & Cox Income DODIX: a patient and disciplined strategy, strong and experienced leadership, and attractive fees. Together with a higher confidence level in the team's foreign-exchange capabilities, it supports an upgrade of the strategy's Morningstar Analyst Rating to Silver from Bronze.

The managers invest with a three- to five-year investment horizon and employ the deep, bottom-up research that is a hallmark of the firm. The strategy's large corporate credit stake, typically near 50% of assets, makes it unique among world-bond peers, which tend to focus more on sovereign debt. Dodge & Cox employs a team of industry, credit, and macro analysts to find the companies, sectors, and currencies that are most appropriate for this strategy's global mandate. The process leads to a concentrated portfolio with high-conviction holdings, including large allocations to emerging markets. For example, in March 2019, it had 28.4% in emerging-markets debt versus 6.5% for its benchmark, the Bloomberg Barclays Global Aggregate Index. The managers also have the flexibility to take both hedged and unhedged currency positions, but it's less aggressive on this front; some competitors invest more than half of their assets in non-U.S.-dollar-denominated securities. This strategy tends to keep its foreign-currency exposure around 20% on average.

Despite a tough start, the fund has generated remarkable returns since inception. The strategy was hit in 2014 as oil prices slid given its energy-related holdings and owing to its euro-sensitive currency positions. Its heavy allocation to credit in 2015--double the category median over the year--again caused it to significantly lag peers as energy holdings struggled. However, it fared predictably well in favorable stretches for credit such as 2016 and 2017; the strategy's 2% annualized return bested close to 90% of peers and outperformed its benchmark by 109 basis points since inception.

Process Pillar: Positive | Benjamin Joseph, CAIA 06/10/2019 The strategy's disciplined process is backed by a strong team, earning it a Positive Process rating.

Consistent with Dodge & Cox's other offerings, this strategy’s process is built on deep fundamental analysis with a long-term outlook. The team leverages the firm's broad research capabilities to pinpoint high-conviction opportunities and isn't afraid to invest heavily in them. This tends to lead to a concentrated portfolio, typically 50-80 issuers, with a profile that can be quite different from its Global Aggregate Index benchmark and category peers. A focus on corporates also tends to yield more than the former, and turnover within the portfolio tends to be lower than most peers’. The strategy tends to hold approximately half of its assets in corporates, but that allocation has reached 60% at times. The rest is distributed between government and related debt, as well as securitized fare. Positions can be denominated in U.S. dollars or foreign currency, and the latter can be hedged. Typically, the fund’s non-U.S. currency exposure will be kept below 20%, but it can be concentrated at times. For example, the strategy had a 9% allocation to the Mexican peso as of March 2017, representing the bulk of its non-U.S.-dollar exposure. Management may also take positions counter to the index, which have included large underweightings to the euro and yen since inception.

This portfolio’s positioning is mostly driven by valuations. From March 2016 through December 2017, the managers reduced corporate credit exposure to 38% from 60% as credit spreads tightened, though it remained significantly overweight to the Global Aggregate Index (18%). In parallel, the team also increased the strategy’s allocation to agency mortgages (to 20% from 9%), preferring their greater liquidity and higher yield than Treasury bonds, as a store of dry powder in anticipation of better valuations for corporate securities.

At the end of 2018’s first quarter, in response to the financials sector’s recent underperformance, the team added to select high-quality financial issuers bringing the corporate exposure back to almost 42%. Over November and December 2018, the managers also used the credit sell-off to push the corporate allocation up to 53%, before trimming it back to its historical average (50%) during 2019’s first quarter as credit rallied. As expected, the exposure to agency mortgages evolved in sync, moving down to 10% at the end of 2018 versus 20% 12 months earlier, and finally back to 13% at the end of 2019’s first quarter.

Within the securitized bucket, agency mortgage-backed securities remain the largest allocation, but the team maintained a 7% allocation to asset-backed securities and a close to 1% position in military housing, a form of agency commercial MBS.

Performance Pillar: Positive | Benjamin Joseph, CAIA 06/10/2019 Despite a tough start, the strategy has generated remarkable long-term returns, supporting a Positive Performance Pillar rating.

The strategy’s typically large allocation to credit makes it more sensitive than both the Global Aggregate Index benchmark and world-bond peers in risk-on and risk-off periods. For example, the strategy was hit in 2014 owing to the oil price slide and its euro-sensitive currency positions, while its heavy allocation to credit in 2015--double the category median over the year--caused it to significantly lag peers. Also, during the credit sell-off over the last two months of 2018, it underperformed its typical peer by 80 basis points.

Though, in 2016, a heavy allocation to corporates and emerging-markets energy names contributed to returns as oil prices bounced back, while in 2017, smart moves across currency exposure, yield curve, and duration positioning helped the strategy outperform two thirds of its peers. It ended 2018 ahead of 60% of its rivals once again thanks to its U.S., Columbian, and Indian rates positions, as well as its position in the Mexican peso, one of few strong-performing emerging-markets currencies for the year.

Overall, this strategy’s returns are strong. From its May 2014 launch through May 2019, its 2% annualized return bested close to 90% of peers and outperformed its benchmark by 109 basis points.

People Pillar: Positive | Benjamin Joseph, CAIA 06/10/2019 The experience and depth of the team here earn a Positive People Pillar rating. The strategy is managed by the firm's global fixed-income investment committee and backed by a deep and experienced team. The six-member committee is composed of long-tenured investment professionals with an average of 21 years of experience with the firm; many have built their entire careers at Dodge & Cox. Each of the committee members sits on at least one other investment committee. Consequently, similar holdings and companies appear across the firm's equity and bond funds.

The committee is backed by the firm’s dedicated fixed-income analysts as well as the firm's 30 industry analysts, who are experts on the major global companies within their sectors. They help develop a house view on those firms and their sectors. Credit analysts pair with industry analysts in their respective industries to determine where the best value is. Analysts are then tasked with intensive research on individual issues to determine which bonds are both attractive and appropriate for the strategy. The macro team was thinner and greener than some category peers, but the firm has started to add head count here and has committed to keep doing so as the strategy grows. The global bond macro committee now counts 12 members, including three people dedicated to macro, currency, and global bond analysis.

Parent Pillar: Positive | 06/27/2019 Dodge & Cox sets a high bar for the asset-management industry. Its many strengths earn it a Positive Parent rating. The San Francisco-based firm, founded in 1930, benefits from a strong investment culture. CEO Dana Emery and chairman Charles Pohl are also lead members of the investment team; they run the firm and its funds with a long time horizon.

But there are no stars here--an intentional and enduring characteristic of the firm. Each fund is run collaboratively by one of five investment policy committees, whose members average more than 20 years at the firm. The analyst ranks are broad and deep, with impressive levels of experience. In all, the firm has approximately 60 managers and analysts, most of whom are Dodge & Cox lifers. Team members rarely leave for any reason other than retirement. The team's financial incentives are appropriately aligned. Portfolio managers invest heavily in their strategies, helping align their interests with investors'. Dodge & Cox is 100% employee-owned, allowing staff to participate in the firm's economic success. Moreover, it has helped Dodge & Cox avoid short-term pressures that often face public firms on Wall Street.

The firm's approach to new strategies is admirable, having rolled out just six in its history. Management has also proved willing in the past to safeguard its strategies by closing funds. All around, Dodge & Cox is a model fund family.

Price Pillar: Positive | Benjamin Joseph, CAIA 06/10/2019 This fund was launched in May 2014 with just $11 million in assets and has grown almost 25-fold to $250 million. In May 2017, Dodge & Cox dropped the expense ratio to 0.45% (excluding certain investment-related costs) from an already low 0.60%, which ranks in the cheapest quartile of similarly distributed no-load peers. This fund earns a Positive Price Pillar rating.