Thursday, September 23, 2010

Dodge & Cox International Stock Fund

We talked with a Dodge & Cox representative on 9/22/2010 about their International Stock Fund. This is one of the “core” funds we typically use in client portfolios (and our own). Dodge & Cox is employee owned; you cannot own shares if you are not currently an employee. There are a significant number of long-tenured employees, and Dodge & Cox has low employee turnover. Everyone is compensated based on firm performance. They feel that is appropriate because it encourages idea and information sharing and because the analysts work on multiple funds

The International Stock Fund has assets under management (AUM) of about $33 billion. It is a low cost fund with an annual management fee of 0.65%. Morningstar calculates that the average fund in the category has an expense ratio of 1.44%. The Fund typically holds from 70-100 names. At the end of the second quarter it had 92 names.

Like all Dodge & Cox funds (they only have five), the International Stock Fund is value oriented. The portfolio is built stock by stock from the universe of companies domiciled outside the U.S. with a minimum market cap of $2 billion. The responsibility for finding the stocks for the portfolio is placed on the firm’s analysts. The analysts typically have global responsibility for multiple industries. They look at a variety of valuation metrics:--price to book, price to cash flow and price to earnings--but there is not one that is dominant. They also look across a company’s entire capital structure given that Dodge & Cox has a bond and a balanced fund.

Analysts develop financial models with 3-5 year forecasts that look at downside, base case and upside surprises as part of a comprehensive assessment of the investment merits of a particular company. Beginning in 2008 Dodge & Cox started formally assigning a devil’s advocate to every investment idea to try to poke holes in the investment thesis. Investment ideas are presented first to a sector committee to vet the analyst’s research and then it is presented to the Policy Committee. This committee not only discusses the investment idea, it also sets the target weights. (Typically an initial position is ½% of AUM, emerging markets positions might start smaller.) The Policy Committee also has responsibility for monitoring regional, industry and sector weightings. Still, the portfolio is built stock by stock with the best ideas from its analysts.

There are very few prospectus restrictions on what the fund can own, how many countries it needs to be in and how many sectors need to be represented. However, the portfolio has been invested in almost all sectors (as defined by Dodge & Cox) almost all the time and has been invested in a minimum of 18 different countries since the fund was started. So, in practice, the fund has been much more diversified than required by prospectus.

The fund currently has a weighting of over 20% in emerging markets. Again there is no prospectus limit but that is the highest it has ever been and seems to be near an informal limit. While the fund continues to have no investments in China because of concern over governance issues, it does own a number of stocks with exposure to China.

Currently, the firm is very excited about equities across the globe. Given the global focus of their analysts, it is interesting to note they are finding, more ideas in the U.S., on the margin, than they have at other times.

We really like the Dodge & Cox International Stock Fund. The research driven, consistent pursuit of the best ideas outside of the United States has led to excellent long term results. While the fund can be volatile (as seen during the 2008-2009 period), we think it is a great way to get exposure to international stocks. We respect the firm’s decision to avoid China, but recognize that will keep the fund out of one of the faster growing, more important countries in the world. We do view it as a core fund for many of our clients.

Returns through 8/31/2010

1 Year
3 Years
5 Years
Since Inception*
Int’l Stock Fund

Source is Dodge & Cox
* Inception is 5/1/2001

(Harvest Financial Partners owns the Dodge & Cox International Stock fund in client portfolios.  The authors own it and the Dodge & Cox Stock Fund in their personal portfolios.  Positions may change at any time)

Wednesday, September 8, 2010

The Fairholme Fund

On her August 27, 2010 show, Wealthtrack, Consuelo Mack interviewed Bruce Berkowitz of the Fairholme Fund.  (Here is a link to the transcript and to the video.) We like Fairholme and have used the fund for our clients since we started Harvest (and have personally invested in the fund for much longer).  The fund and its managers have rewarded that decision, having a fantastic relative and absolute 10 year track record, so fantastic that Morningstar named Mr. Berkowitz its domestic stock fund manager of the decade. 

While we are comfortable with the people, the investment philosophy and the implementation of that philosophy, we are watching two developments with the fund.  First is size, not surprisingly Fairholme has attracted a lot of new investors, pushing the fund size to $15 billion.  Historically, as the size of a fund has increased, relative outperformance has declined. No less an investor than Warren Buffett made that same point.  He wrote in his latest Berkshire Hathaway shareholder’s letter (as he has previously):

The big minus is that our performance advantage has shrunk dramatically as our size has grown, an unpleasant trend that is certain to continue..But huge sums forge their own anchor and our future advantage, if any, will be a small fraction of our historical edge.

Mr. Berkowitz, in the interview, claims that the large size of his fund is an advantage and that it gives him an opportunity to make investments he could not have made in the past.

The second area we are watching is Fairholme’s large position in financials such as AIG, MBIA, Citigroup, CIT, Bank of America and Goldman Sachs.  According to the interview these stocks represent about 60% of the fund’s stock holdings.  (Fairholme has one third of the fund in cash and fixed income.)  Our issue with financials, particularly banks, is that it is difficult to know what the assets are really worth even after looking at the companies’ financial statements.  In the interview, Mr. Berkowitz discusses why he thinks financial stocks are good values with limited downside.

Now if any manager has earned the benefit of the doubt, it’s Bruce Berkowitz and his team at Fairholme.  And while we would not call ourselves doubters, we will be watching to see how the fund manages the size issue and how the large investment in financials plays out.

(Harvest Financial Partners holds this fund in some of its clients' portfolios. The principals of Harvest also own the Fairholme Fund. Holdings may change over time.)