A Contrarian with Winning Results


Going against the grain could sum up the investment philosophy of Dodge & Cox Stock Fund (DODGX), according to John Gunn, one of the fund's managers and president and chief investment officer of the San Francisco-based firm. The fund takes a contrarian approach, picking up beaten-down stocks that are temporarily out of favor. Unlike most money managers that offer different types of funds, Dodge & Cox's 30-member equity-investment team sticks to one philosophy: building a portfolio of undervalued companies with attractive long-term prospects.

Dodge & Cox Stock Fund was the fifth-best performing large-cap value fund for the 10 years through Mar. 31, returning an annualized 12.7%, vs. 7.4% for its peers. For the three-year period ending Mar. 31, the fund rose 2.4%, compared with a 7.9% decline for the average large-cap value fund. Based on quantitative and qualitative criteria, Gunn and the fund's team were selected as one of 10 winners of the first annual Standard & Poor's/BusinessWeek Excellence in Fund Management Awards.

Bill Gerdes of S&P's Fund Advisor recently spoke with Gunn about the fund's strategy. Edited excerpts from their conversation follow:

Q: You tend to hold stocks that do well over the long term. How do you find them?

A: Our turnover is about 15% to 20%, and valuations are very important to us. We try to buy stocks of companies with durable business franchises for the next four to five years. We usually buy them when they're under a short-term cloud.

We try to avoid overvalued stocks. When considering a potential holding, we ask how it would do if we put it in a safety-deposit box for four years. For the last three years, we've avoided two-thirds of the stocks in the S&P 500, because we thought they were overvalued.

Q: A lot can happen to a stock in four years.

A: We constantly look at our holdings. Everyday, you implicitly repurchase your portfolio if you don't change it. We're always trading, but we don't make huge shifts. We don't think anyone can forecast short-term moves.

Q: Why do few other funds follow your strategy?

A: One key advantage we have is that we're independent. Dodge & Cox was founded in 1930 by Van Duyn Dodge and E. Morris Cox. They were disillusioned by the excesses of the 1920s equity market and firms making money from transactions, rather than from how the clients did.

Today, we manage about $70 billion in total net assets, with about $27 billion in mutual funds. We follow a very disciplined approach, and the equity portfolios for all our clients are very similar.

Q: Many investment firms recommend customized portfolios for investors based on their particular circumstances.

A: Few money-management firms follow our approach because you only have one product [with our approach]. Either it does well, or it doesn't. Also, more products may mean higher profits for investment firms. We focus all our efforts on one portfolio and try to know our holdings as well as we can.

Q: What are the main features of the fund's management structure?

A: About 30 investment professionals work on the fund, with 10 in policymaking positions. It's a group-decision process -- we don't have a star management system. We continually put ideas through the gauntlet. We're contrarians, and stocks with low valuations often go through frightening things. When you're whistling in a graveyard, you have to have someone holding your hand.

Q: What are the most important investment themes in the fund?

A: We're

bottom-up investors. Consumer discretionary is our largest sector, but our holdings in that area range from Sony (SNE), to retail, to autos, to Whirlpool (WHR).

We focus on areas of long-term growth, which usually benefit from declining costs due to technological innovation. We hold Hewlett-Packard (HPQ) and Corning (GLW), which we previously sold and repurchased after they fell in price. We have a fairly large position in Xerox (XRX) and think its management is doing a lot of the right things.

Q: Do you following any broad macroeconomic trends?

A: We consider some top-down themes. We think the global economy is in the beginning phases of a long-term expansion. Over the next 5 to 10 years, there won't be much upside in U.S. consumer spending, and Europe and Japan have limited potential due to their demographics.

The key to global growth in the long term is the developing world. Citizens there are gradually organizing to produce and consume more. It's a herky-jerky process. The only threat is insecurity and terrorism, but the U.S. is working to control these issues.

There's no parallel in economic history for the potential growth of the developing world. Technology, particularly the declining cost of communication, will provide a big push. Sony will play a key part in this process.


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