To Our Shareholders
The Dodge & Cox Global Stock Fund — Class I had a total return of -7.69% for the six months ended June 30, 2022, compared to a return of -20.18% for the MSCI ACWI Index and -20.51% for the MSCI World Index.
Market Commentary
After strong performance in 2021, global equity markets pulled back significantly in the first half of 2022. Every major region was down, and every sector—except for Energy (up 15%)—posted a decline. As central banks in many parts of the world started to hike interest rates, the market’s focus shifted from high inflation to the risks of a potential recession. U.S. interest rates, for example, increased in the first half of the year from 1.5% to 3.0%,1 but the yield curve flattened, signaling expectations for lower economic growth in the future. The MSCI ACWI declined 20% on compressed valuations, and now trades at 14.0 times forward earnings2 compared to 18.3 times at the end of last year.
Value stocks3 outperformed growth stocks significantly, with the MSCI ACWI Growth Index4 declining 28%, versus a decline of 12% for the MSCI ACWI Value Index5 in the first six months of the year. Remarkably, the valuation premium for growth was previously so large that even with the MSCI ACWI Value gaining 16 percentage points of relative performance, the discount for value stocks still remains very wide. The MSCI ACWI Value trades at 10.8 times forward earnings, compared to 20.2 times for MSCI ACWI Growth. Value stocks tend to trade at a discount to growth stocks, however the current discount is currently wider at 0.5 times relative earnings, versus a historic average of 0.7 times.
Over this period, the Fund outperformed the MSCI ACWI by 12.5% percentage points.
Investment Strategy
Markets characterized by uncertainty or wide valuation disparities can play to Dodge & Cox’s strengths. These include a long-term investment horizon, a disciplined focus on valuation, and our deep knowledge of industries and company fundamentals, grounded in our research and an experienced and long-tenured investment team.
These unique characteristics enable us to invest in companies that may not look attractive in the short term, but whose longer-term prospects look bright. Examples include companies at discounted valuations due to past organizational missteps, others facing shorter-term industry headwinds, or those which could benefit from a potential catalyst such as a turnaround, new management or strategy, or breakup opportunity. In other cases, secular growth prospects may not be fully reflected in the current price. While it is difficult to know when value will be recognized, we are fortunate that Dodge & Cox’s independent ownership enables us to stay the course, even when our investments are out of favor, as was the case with value stocks during the 2018 to 2020 period.
The Fund’s outperformance during the first half of 2022 stemmed from our ability to stick with the Fund’s investments in Energy, Health Care, and China Internet. We maintain a rigorous investment process across market cycles, weighing what we are buying (company fundamentals) against what we are paying (current valuation). For each potential investment, our global industry analysts develop three- to five-year earnings and cash flow projections, along with an assessment of the risks and opportunities, to derive a range of potential investment returns over our investment horizon. Our team-based approach provides further checks and balances, tests our conviction, and broadens our knowledge base over time.
Market Volatility Has Created a Broader Set of Investment Opportunities
Recent market concerns have opened up several new opportunities for our portfolio. We started new positions in Entain, General Electric, and Stellantis (STLA, Financial) this year, each with different stock specific catalysts in different industries: one is a growth opportunity, one is a turnaround and breakup situation, and one is a deep-value cyclical company.6 What they share in common is a significant drawdown in valuation. In addition, we added to the Fund’s holdings in Consumer Discretionary and Communication Services, including U.S. and China Internet companies, as well as Financials. We discuss two of the Fund’s new positions below.
General Electric
We have followed General Electric (GE, Financial) closely for over 30 years, holding meetings with GE’s management and investor relations teams and conducting calls with competitors, industry experts, former employees, sell-side analysts, and others. Our deep institutional knowledge enabled us to respond to the price decline in the first half of 2022 and start a position, amid concerns about inflation and supply shortages.
We believe GE will continue to benefit from a decade of corporate restructuring and balance sheet clean up. Led by CEO Larry Culp, management recently announced its intention to split into three separate companies by fiscal year 2024. We believe the split-up will provide the potential to create more value than is recognized in the current conglomerate structure. Our analysis shows GE trades at over a 50% discount to its sum-of-the-parts valuation. As management reduces corporate overhead and investors gain confidence in its ability to separate the company according to plan, we believe the discount to GE’s sum-of-the- parts valuation will narrow significantly. GE was a 0.8% position on June 30.
Entain
Entain (LSE:ENT, Financial) is a UK-based global gaming operator with leading market share positions in the largest ex-U.S. online gaming markets. The company also has a 50/50 joint venture with MGM Resorts called BetMGM, an online sports betting and iGaming operator serving the U.S. market. We believe the company can grow free cash flow at a double-digit rate over our three- to five-year investment horizon as online penetration of gaming increases and the company expands further into new, high-growth territories. BetMGM currently has the second-highest market share in the fast-growing U.S. online gaming market, which is expected to reach over $20 to $50 billion in revenue over the next five to seven years. While regulation could impact Entain’s profitability or slow its growth trajectory, we believe states across the United States will continue to legalize online gambling. Entain (0.5% position) trades at 13.7 times forward earnings.
The Fund Is Broadly Diversified with Multiple Opportunities
The Fund is well balanced across various investment themes, stemming from our individual security selection. To highlight the opportunities we are finding, we group the portfolio into three categories:
Overweight Economically Sensitive and Deep Value Sectors
The Fund is overweight the Financials, Energy, and Materials sectors (38% versus 24% for the MSCI ACWI). These holdings trade at attractive valuations and should benefit from rising interest rates. We also expect the Fund’s energy holdings, as well as many of its materials holdings, to benefit from strong commodity price fundamentals.
During the first half of 2022, we added significantly to the Fund’s financial services holdings, including Charles Schwab (SCHW, Financial), Prudential (LSE:PRU, Financial) (UK), BNP Paribas (XPAR:BNP, Financial), and BNY Mellon (BK, Financial). Most of the Fund’s Financials should benefit from a rising rate environment. However, our return expectations do not rely on a higher rate environment given already very low starting point valuations. Our conviction rests instead on company-specific factors as key drivers of return. After evaluating how an economic downturn or other factors might affect their earnings power and ability to return capital, we continue to believe these holdings are attractive.
Energy was the best-performing sector of the MSCI ACWI in the first half of 2022. As the Fund’s energy holdings outperformed (up 62% compared to up 15% for the MSCI ACWI sector), we trimmed Occidental Petroleum (OXY, Financial), Suncor Energy (SU, Financial), and Schlumberger (SLB, Financial) on strength. Despite these trims, the Fund remains overweight this key sector of the market. Amid higher oil and natural gas prices and restrained capital spending, the Fund’s energy holdings now trade at very attractive free cash flow yields7, creating the conditions for potentially higher capital return.
Modestly Overweight Innovation-Led Sectors
The Fund also has significant exposure to innovation-led earnings growth opportunities through its investments in reasonably valued technology, internet, and health care companies (49% versus 45% for the MSCI ACWI) . During the first half of the year, we added opportunistically to several Internet holdings, including our investments in three China Internet companies (Prosus (XAMS:PRX, Financial), Alibaba (BABA, Financial), and JD.com (JD, Financial)). Valuations have pulled back significantly and do not appear to price in the potential that heightened regulatory headwinds might improve.
Underweight the Rest of the Market
The portfolio remains underweight the rest of the market (13% versus 31% for the MSCI ACWI), where valuation opportunities are less plentiful. However, the Fund does have selective smaller exposures within Consumer Staples, Consumer Discretionary (excluding internet retail companies), and Industrials.
In Closing
We are optimistic about the opportunities that we see as value-oriented, active managers. Our team continues to research new investment ideas and adjust the portfolio in response to changes in the market. The Fund is well diversified and positioned for a variety of macro outcomes.
Experience, patience, and persistence matter, especially in times of uncertainty. Our organizational strengths—long-time horizon, focus on research and valuation, organizational independence, and long-tenured team—help to create the necessary conditions for long-term investment performance. Investors who react to news headlines often change course at the wrong time. This is why it is critical to maintain a long-term investment horizon. We encourage our shareholders to take a similar view.
Thank you for your continued confidence in our firm. As always, we welcome your comments and questions.
For the Board of Trustees,
Dana M. Emery, Chair and CEO
July 29, 2022
- These are the 10-year U.S. Treasury rates.
- Unless otherwise specified, all weightings and characteristics are as of June 30, 2022.
- Generally, stocks that have lower valuations are considered “value” stocks, while those with higher valuations are considered “growth” stocks.
- The MSCI ACWI Growth Index captures large- and mid-cap securities exhibiting overall growth style characteristics across 23 developed Market countries and 24 emerging market countries. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.
- The MSCI ACWI Value Index captures large- and mid-cap securities exhibiting overall value style characteristics across 23 developed market countries and 24 emerging Market countries. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price and dividend yield.
- The use of specific examples does not imply that they are more or less attractive investments than the portfolio’s other holdings.
- Free cash flow is the cash a company generates after paying all expenses and loans. The free cash flow yield compares a company’s free cash flow per share with its market price per share. A high free cash flow yield means a company is generating enough cash to satisfy its debt and other obligations.
Returns represent past performance and do not guarantee future results. Investment return and share price will fluctuate with market conditions, and investors may have a gain or loss when shares are sold. Mutual fund performance changes over time and may be significantly lower than stated above. Performance is updated and published monthly. Visit the Fund’s website at dodgeandcox. com or call 800-621-3979 for current month-end performance figures.
Before investing in any Dodge & Cox Fund, you should carefully consider the Fund’s investment objectives, risks, and charges and expenses. To obtain a Fund’s prospectus and summary prospectus, which contain this and other important information, visit dodgeandcox.com or call 800-621-3979. Please read the prospectus and summary prospectus carefully before investing.
