Dodge & Cox Global Stock Fund shareholder letter for the fourth quarter 2014.
To our shareholders
The Dodge & Cox Global Stock Fund had a total return of 6.9%, compared to a return of 4.9% for the MSCI World Index for the year ending December 31, 2014. At year end, the Fund had net assets of $5.9 billion with a cash position of 3.1%.
Dodge & Cox Global Stock Fund: Market commentary
During 2014, global equity markets continued to increase. U.S. dollar appreciation detracted from returns: the MSCI World was up 10% in local currency and up 5% in U.S. dollars; the MSCI Emerging Markets Index was up 5% in local currency and down 2% in U.S. dollars.
Economic activity expanded at a moderate pace in some major markets (e.g., United States, United Kingdom). In the United States (S&P 500 up 14%), the economy rebounded and continued to expand through December. U.S. labor market conditions improved: job gains were solid and the unemployment rate declined. While the recovery in the housing sector remained modest, household wealth and spending rose, and consumer sentiment reached a seven-year high. Corporate profitability was robust, and businesses increased investment in fixed assets. The U.S. Federal Reserve (Fed) announced the end of its historic asset-purchase program, but retained an accommodative stance and signaled its intention to take a slow approach toward raising interest rates in 2015.
Internationally, the Eurozone showed significant weakness, as stagnation and deflation concerns rose and manufacturing data disappointed. Economic activity contracted in Japan on the heels of a sales tax hike and declines in business investment. Slowing growth in China weighed on commodity prices.
Global oil prices plummeted approximately 50% amid lower-than-expected demand growth and modestly higher-than-expected supply growth. OPEC did not cut production as many had expected. While consumers and oil importers benefited from lower oil prices, many oil-exporting countries suffered. Despite some mixed news about global economic growth, our long-term outlook for equities continues to be positive.
Dodge & Cox Global Stock Fund: Investment strategy
Our disciplined investment process combines in-depth, bottom-up research and rigorous debate of ideas among our experienced investment professionals. The Fund benefits from the collective judgment of our team. We evaluate potential investments based on a three- to five- year investment horizon and have a strict price discipline. Individual company research is the primary factor in determining the Fund’s portfolio composition.
The best investment opportunities often arise during periods of great uncertainty. Macroeconomic conditions are many times not embedded appropriately in company valuations, and we find opportunities when other investors are exceptionally pessimistic. For example, in 2013 the Fed decided to begin tapering its quantitative easing program, and certain countries reliant on external funding (e.g., India, Brazil, Turkey) proved vulnerable, and experienced significant currency and/or market declines. Valuations decreased to the point where we saw investment opportunities arise in certain developing world companies. As a result, we added to select holdings in emerging markets and started new positions that have since outperformed and contributed to the Fund’s strong relative performance in 2014.
During 2014, we identified numerous investment opportunities within the Financials sector where valuations reflected meaningful pessimism about the macroeconomic backdrop, significant changes in commodity prices, and the banking industry’s ability to earn a return with greater regulatory oversight. Standard Chartered and Siam Commercial Bank (a new holding) are two such examples.(a) The Fund’s sector and industry positioning results from individual security selection: 23.6% of the Fund was invested in Financials compared to 20.9% of the MSCI World on December 31.(b)
Dodge & Cox Global Stock Fund: Standard Chartered
Domiciled in the United Kingdom, Standard Chartered has extensive geographic reach. The company provides consumer and wholesale banking products to customers throughout the emerging markets (especially in Asia, Africa, and the Middle East); approximately a third of the company’s deposits are located in Greater China. Falling commodity prices, concerns about asset quality, regulatory fines, and increasing capital requirements in the United Kingdom weighed on the company’s share price, and its valuation fell to 0.8 times book value in October, a historically low level.
Standard Chartered has been held in the Fund since 2008. Over the years, we have spent considerable time researching and analyzing the company in various market environments. Standard Chartered’s broad network across the developing world would be very difficult to replicate today. The company’s global payments and trade business is a particular strength: local roots from its longstanding presence allow for local currency funding, and cooperation across the network provides integrated wholesale banking services to clients. The bank is exposed to economic growth and increasing trade flows in emerging markets.
We acknowledge the current risks and believe that Standard Chartered’s inexpensive valuation, coupled with its long-term growth opportunities, makes it an attractive investment. We substantially increased the Fund’s exposure to Standard Chartered during 2014. On December 31, Standard Chartered was a 1.7% position in the Fund.
Dodge & Cox Global Stock Fund: Siam Commercial Bank
Siam Commercial Bank, the largest retail bank in Thailand, is a new addition to the Fund. During late 2013 and early 2014, Thailand lacked a functioning government, and the country’s stock market suffered. Siam Commercial’s stock was no exception, as its valuation declined to eight times forward earnings. During prior periods of political uncertainty, the Thai economy continued to grow, and Siam Commercial delivered an attractive return on shareholder’s equity and increased its book value per share.
As a part of our due diligence process for owning Kasikornbank in Thailand, we had closely followed Siam Commercial to understand the competitive landscape. After conducting additional in-depth research, we concluded that these political concerns provided us with a long-term investment opportunity at a low valuation. Siam Commercial’s leading positions in retail banking and fee-related financial services provide it with a durable franchise. We believe that the company’s high return on equity—generated by a combination of stable net interest margins, high fee income, ample provisions, efficient operations, and moderate leverage—is sustainable over our investment horizon. Furthermore, we believe that Siam Commercial is well prepared to absorb economic volatility, given its high profitability, capital levels, and loan loss reserves. After weighing these opportunities against the political risk, we initiated a position; Siam Commercial was a 0.4% holding in the Fund at year end.
Dodge & Cox Global Stock Fund: In closing
We continue to see long-term opportunity for global equities as we look for attractively valued investments in both developed and emerging markets. Global equity valuations remain reasonable: the MSCI World traded at 15.5 times forward estimated earnings (compared to a 20-year average of 16.1 times) with a 2.4% dividend yield at year end. Corporate balance sheets and cash flows continue to be strong. The Fund is invested in companies that we believe have favorable long-term prospects over our three- to five-year investment horizon. Acknowledging that both share prices and currencies can be volatile in the short term, we encourage shareholders to remain focused on the long term.
Thank you for your continued confidence in our firm. As always, we welcome your comments and questions.
For the Board of Trustees,
Charles F. Pohl,
Dana M. Emery,
January 27, 2015