Dodge & Cox's Keys to International Investing Success
Focusing on fundamentals, tuning out noise, and practicing patience has worked for Morningstar's 2014 International-Stock Manager of the Year.
Gregg Wolper: Hello, I am Gregg Wolper, senior analyst at Morningstar, and I am here with Diana Strandberg and Charles Pohl of Dodge & Cox. They are two members of the team that runs Dodge & Cox International Stock Fund (DODFX), and that team has just been named Morningstar's International-Stock Fund Manager of the Year for 2014. So, welcome and congratulations.
Diana Strandberg: Thanks, Gregg. It's really a honor.
Wolper: Well, we appreciate you coming here, and the award was well deserved. We just have a few questions for you to help our viewers learn more about you. I think one of the hallmarks of the fund is its low turnover rate. At a time when there is tremendous volatility in the markets and crazy events seem to be going on all the time--whether it's central banks or economies--I think that it's hard to understand how you can keep your stocks for such a long time without much trading. It's a much lower rate, about 12% or 14% per year, when a lot of other funds are in the 70s, 80s, or even over a 100. How do you manage that?
Diana Strandberg: First, we'd observe that stock prices move much more dramatically than long-term company fundamentals, and we remain focused on the long-term company fundamentals when we make an investment in a company.
Charles Pohl: On top of that, I think that people should consider the fact that turnover is not free. There is a cost to it. So, a low-turnover strategy, a long-term investment strategy, incurs significantly fewer costs for the investors, and so that leads to, we think, better returns over time.
Strandberg: I think something that we hope our shareholders appreciate is that the short-term volatility actually gives us numerous opportunities to nudge positions--to add a little bit or trim a little bit to a long-term position.
Wolper: One of the areas you've always had a higher-than-average stake in is emerging markets. That goes back a long way. It's often double the category average. Now, everyone knows that there are higher growth rates in emerging markets. And yet, that doesn't always translate into higher company share prices, better company performance, just because country's GDP is growing at a higher rate. So, what explains the higher emerging-markets stake?
Strandberg: Well, we do agree that growth rates are higher in the developing world than in the developed world, but we're pretty agnostic about domicile in the following way: We're looking at individual companies. We're weighing the caliber of their management teams, the strength of their business franchise, the competitive position, their financial wherewithal, and we're weighing that--what we're buying, if you will--against what we're paying, the valuation end. We think about macro factors, governance, and other very important ingredients as really part of that full picture of a company. So, it happens to be that we have found 21 companies that are domiciled in emerging markets where we think the long-term prospects are very attractive in relation to the current valuation.
Wolper: I see. So, it's not necessarily a call that emerging markets are going to outperform developed markets.
Strandberg: No. It's all about individual companies. And in fact, we have a number of companies in the portfolio that are domiciled in developed markets--Erikson in Sweden, the telecom-equipment provider, would be an example--that have extensive emerging-markets reach.
Wolper: For many years, Dodge & Cox did not hedge currency exposure, and then about--I don't know--five or six years ago, you did do that. An unusual case. Since then, it's not uncommon to find at least one currency, sometimes two, hedged. So, even though you are not doing it that much or to a great extent, it has become more common. So, what changed?
Strandberg: Well, let's step back. When we launched the International Stock Fund in May of 2001, the trade-weighted dollar was at a high level and has been a tailwind as it's weakened against foreign currencies, really, for much of the fund's existence. We've been building our currency expertise as part of our becoming better investors. We're a learning organization. So, as we've been building that expertise, and then as the years went by, there were some significant changes in the value of the dollar against the euro or the pound or the yen, for example. Those changes--that valuation change, really, in the dollar--was starting to come into our investment discussions. We were seeing companies that we liked, but we were concerned about the currency. We felt, as a committee, that we could take that risk off the table and preserve our ability to continue to be long-term investors in individual companies that we like.
Pohl: Another point on that is, when the fund was launched, the trade-weighted dollar was at a real peak. If you look back over the years since we launched the International Fund in 2001, the trade-weighted dollar has declined quite a lot. Now, there has been a rally here the last year, but it's still at comparatively much lower levels. So, investors in international funds, in general, have benefited, including in the Dodge & Cox International Fund, a great deal in terms of their absolute return from this declining dollar.
If you look at it on a go-forward basis, and certainly in the course of the last year, that went the other way. And I think that we are increasingly concerned that we try to ensure that our investors are not hurt by a reversal of this long-term decline in the dollar and that we're careful about trying to protect our investors.
Wolper: The Manager of the Year award is for one year, for 2014; however, we are very careful to recognize managers who also have very good long-term records, and that's one reason Dodge & Cox International Stock was recognized. But it is Manager of the Year, and so we're curious about what you think helped the fund outperform in 2014. It was a very tough year for foreign markets and foreign currencies, so just avoiding a loss was very difficult. Most funds ended up in the red, sometimes deep in the red. You managed to avoid a loss. How did you do that?
Strandberg: Well, we do want to start out by recognizing we avoided a loss by 7 basis points. So, we're very pleased about the relative performance, but we like to do better for our shareholders in absolute terms than that. I think it really boils down to our ability to build conviction and stay with those convictions--that persistence and really remaining long-term. So, some of the ingredients that went into our performance in 2014 were, for example, our collection of investments that are domiciled in the emerging markets collectively rose 14% for the year.
Now, we were building some of those positions when the Fed taper talk started in May of 2013. We saw deep plunges in certain currencies around the world, steep declines in certain emerging-markets stock markets around the world, which is another way of saying valuations dropped a lot. And that caught our attention. We were selectively adding to holdings such as ICICI (IBN), the Indian bank, or Kasikorn (KPCKF), the Thai bank, as well as we started some new positions in the portfolio: Baidu (BIDU), the Chinese Internet company, would be an example; Samsung (005930), the Korean consumer-electronics company, would be another example. And those helped.
Technology and media also helped performance. So, Hewlett-Packard (HPQ) was a strong performer for second year in a row for us, as well as some of the selected other technology and media holdings that we had persisted with.
Wolper: Now, in the fund industry, team management has become more common; but that usually means one true lead manager or maybe two co-lead managers, and they are supported by comanagers. But at Dodge & Cox, you call it a committee--the nine people running your fund--and it really is more of a true team management, which is unusual. The question is how do you avoid the problems of real committees where there are nine people, where there's not an identified lead manager? How do you avoid the problems of, say, groupthink? Or in a committee if no one really wants to take ownership of an idea? Or indecisiveness? How do you manage that?
Pohl: Well, I think you've had a couple of interesting points, and they are good ones. Committees can be prone to groupthink, and it's something that we're aware of and very conscious in trying to work against. One of the devices that we've set up is, as we're evaluating new investment ideas, we will appoint a devil's advocate, somebody who is appointed to research the idea and present the opposing point of view to the group so that we see that there is an opposing point of view that's strongly advocated, well thought out, and put in front of us. So, that helps to break up the groupthink where we're all thinking about this the same way because we force the opposing point of view in front of us.
The other thing that you raised was whether committees can make decisions quickly or decisively. I think there are a couple of points. One is that we've all worked together for a long time. Note the very long tenure that we all have together on these committees. So, I think we understand each other and we work very well together, and so it's more efficient than if you just brought a group of strangers together who might have to work out a lot of issues between themselves.
The other thing is that our whole process is long-term oriented. As you noted earlier, we have low turnover, we're very deliberate, we're very careful in our research. A great deal of due diligence goes into these decisions. So, we make these decisions slowly when, as Diana frequently likes to say, we're nudging these positions one way or the other. So, that committee decision-making, that high level of process and a lot of due diligence, works well with our basic strategy, which is to be a long-term investor and keep ourselves focused on the long term.
Strandberg: I would just add two quick things to that. One is there's always an advocacy when we sit down as a committee to meet. Typically, it's the analysts, but it can come from any member of the investment team. So, we are there to actually do something, and we recognize that waiting to get more information is an active decision that we are taking, for example. So, there is an advocate, and what we want to do is then bring it into that group decision-making.
For the second point, the purpose is to broaden out our perspective on the risks and opportunities so that we can bring some experience and judgment into the room as we are looking at that deep and very thorough due diligence into the investment. So, we've worked together over a long period of time. We share an investment philosophy. We know we're there to do something. And we have the full array of risks and opportunities on the table so that we can make the best-informed decision possible.
Wolper: You mentioned, Charles, how long so many of the people at Dodge & Cox have been there, the long tenures of the managers and the analysts. That is also somewhat unusual in this industry. There are long-tenured managers, of course, but many investment professionals move from firm to firm over the years. How have you managed to keep people there for so long? Is it in the training? Is it who you hire to begin with, or is it something else?
Pohl: There are two things, I would say. One is--and we were just talking about this--it's a group decision-making process. It's a very collegial firm, we work together, and I think people like participating in that. It's sort of like a family. We're all friends, and we're working together toward a common goal. So, I think that's an attractive work environment for people who are highly motivated professionals.
Then, the second thing I think that is important is the fact that Dodge & Cox, per its bylaws--Mr. Dodge drew these up when the firm began--is required to be owned only by active employees of the firm. So, it's a deal where we can offer younger people, who have been with us for a few years and show a lot of promise, significant ownership stakes in the firm. So, they become tied into the business that way as well and get to participate in its success, and I think that's a very powerful thing for attracting the best people and also for retaining them over a long period of time.
Wolper: Now, this fund has become very popular in the past few years. It's been popular for a while, but the inflows have really come in recently. For years, you have said that that really was not affecting in any way negatively your investment process. Earlier this year, though, Jan. 16, the fund did close to new investors. Could you explain why you made that decision?
Strandberg: Well, we look at capacity routinely as part of really thinking about the long-term health of our firm, as well as what's in the best interest of our current clients and shareholders. So, you're right to observe that; we don't think that the flows have affected what we're able to do. We continue to find ample investment opportunities in both the developed and the emerging markets. We felt, though, that the flows were at a significant enough level that we wanted to just tap the breaks a little bit so that our current shareholders could continue to grow with us for the foreseeable future.
Wolper: So, as of yet, you hadn't seen any impediments to investing from the size of the fund?
Strandberg: No. We take decisions well in advance, typically, of when there is a need to do that.
Wolper: Well, thank you very much for appearing. Welcome, again, to Morningstar. And again, congratulations on your award.
Pohl: Thank you very much.
Strandberg: Thank you so much. The team is really honored.
Gregg Wolper has a position in the following securities mentioned above: DODFX. Find out about Morningstar’s editorial policies.