They did fine for years. Now they are starting to make serious mistakes. How will they do THIS year when the bond market collapses?


What Went Wrong at Dodge & Cox?
The firm's intensive research failed to anticipate the implosion in financial stocks.
By Andrew Tanzer, Senior Associate Editor
From Kiplinger's Personal Finance magazine
February 2009

In the sales-driven mutual fund world, there's a lot to like about Dodge & Cox, the sedate San Francisco fund manager. The firm keeps a low profile. It doesn't advertise, market products or chase fads.

Instead, its long-tenured managers focus on running just five low-cost funds. The managers and other Dodge & Cox employees own the firm and invest their wealth side by side with outside shareholders.

Over the years, D&C's disciplined and long-term-oriented investment process has handsomely rewarded loyal shareholders. For instance, during the 20 years through November 30, 2008, Dodge & Cox Stock (symbol DODGX returned an annualized 10.2%.

That was an average of two percentage points per year better than Standard & Poor's 500-stock index, an impressive feat, and good enough to land Stock among the top 10% of all funds, according to Morningstar.

Recently, though, Dodge & Cox has seemed almost accident-prone, and all of its funds have posted weak results. D&C Stock, for example, lost 46% in the first 11 months of 2008, seven points worse than even the execrable performance of the S&P 500 and a basket of large-company value funds.

Over the years, the rigorous research efforts and long-term horizon have paid off. For instance, D&C Stock has reaped large gains over the long run in stocks such as FedEx, Hewlett-Packard and Wells Fargo. Clearly, the professionals at Dodge & Cox are thoughtful, patient and sober investors. So where did they come unstuck? Their main error was to gravely underestimate the risks in financial stocks -- such as American International Group, Fannie Mae and Wachovia -- that its funds loaded up on.

At the end of 2006, Stock actually held a below-average weighting in financial stocks: 14%, compared with the sector's 22% weighting in the S&P 500. After the subprime-mortgage and credit crisis began to erupt in mid 2007, financial stocks started to tumble. As prices of financial stocks plunged in the second half of 2007 and the first half of 2008, Dodge & Cox was buying. By June 2008, Stock was overweight in financials, with a 17% allocation, compared with 14% in the index. In the letter to Stock shareholders reporting on the second quarter of 2008, the managers wrote: "We have selectively expanded the Fund's financials weighting because in our opinion their valuations have declined more than their underlying long-term fundamentals have deteriorated."

Just a few months later, the roof caved in on financial stocks.

Read the entire story at this link.

www.kiplinger.com/magazine/archives/2009...