The Dodge & Cox Global Stock Fund had a total return of -0.4% for the third quarter of 2019, compared to 0.5% for the MSCI World Index. For the nine months ended September 30, 2019, the Fund had a total return of 11.8%, compared to 17.6% for the MSCI World.
INVESTMENT COMMENTARY
Growth stocks continued to outperform value stocks2 year to date, as valuations of technology-related companies continued to rise, amidst some volatility. Over the last decade, the MSCI World Growth Index has outperformed the MSCI World Value Index by an average of 3.4 percentage points per year.3 Despite posting higher earnings growth and dividend yields, the MSCI World Value underperformed due to significant valuation compression.
We think this is an opportune time to be a value investor. The valuation differential between value and growth stocks is now exceptionally wide by historical standards. The MSCI World Value trades at 12.6 times forward earnings, while the MSCI World Growth trades at 20.7 times.4 In the last year, we trimmed holdings in Communications Services and Health Care as valuations rose, and invested more into Financials and Energy, two of the largest sectors of the MSCI World Value. Based on individual security selection, the portfolio is tilted toward value stocks and overweight Financials (30.7% of the portfolio versus 15.7% of the MSCI World), Health Care (17.4% versus 12.4%), and Energy (9.5% versus 5.2%).
Over the past ten years, U.S. equities also significantly outperformed international equities, primarily due to meaningful valuation compression in international markets relative to the United States. The S&P 500 Index returned 247% compared to 61% for the MSCI EAFE Index over the period, and as a result, the current valuation spread between U.S. and international equity markets is now near a 15-year high.5 As a result, the Fund is also tilted towards international equities relative to the MSCI World, at 53.2% compared to 36.9%.
At the intersection of these two attractive parts of the market is European Financials. We believe the Fund’s holdings in this area continue to represent excellent long-term opportunities. European Financials are trading at low valuations associated with previous periods of severe economic stress, yet are much more resilient today, with greatly improved fundamentals. While our baseline expectation is for a prolonged period of both low growth and low interest rates in Europe, any improvement in the macroeconomic backdrop has the potential to drive further upside. On a bottom-up basis, we recently added to the Fund’s positions in BNP Paribas, Societe Generale, and UBS Group.
In Energy, we continue to find long-term opportunities in selected upstream and oilfield services companies with assets on the low end of the global cost curve. For example, we recently added to the Fund’s position in Occidental Petroleum, which completed its acquisition of Anadarko Petroleum (previously held by the Fund) in August 2019. While there are concerns about the deal’s high cost of financing, we have conducted extensive due diligence and believe Occidental’s risk-reward profile is compelling due to its strong operational capabilities, attractive valuation, and an upstream portfolio that generates substantial free cash flow. We also initiated a new position in Encana, one of the largest shale oil producers in North America. This company is also a low-cost operator with high-quality assets, and possesses industryleading operational expertise in shale basins, which should generate substantial free cash flow relative to its current low valuation of seven times forward earnings.
The Fund’s valuation tilt is clearly reflected in the portfolio’s attractive valuation of 11.5 times forward earnings, compared to 15.8 times for the MSCI World. During this challenging decade for value investors, the Fund has outperformed the global value investment universe by 27 percentage points, while also modestly outperforming the MSCI All-Country World Index, and modestly underperforming the MSCI World.6
We remain optimistic about the long-term outlook for the Fund and encourage our fellow shareholders to focus on the long term. Thank you for your continued confidence in Dodge & Cox.
T H I R D QU A RT E R P E R F O R M A N C E R E V I E W
The Fund underperformed the MSCI World Index by 0.9 percentage points during the quarter.
KEY DETRACTORS FROM RELATIVE RESULTS
- Weak returns from holdings in the Information Technology sector (down 3% compared to up 2% for the MSCI World sector) hurt results. Micro Focus International (down 44%) was a large detractor.
- The Fund’s average overweight position in the Financials sector (30% versus 16% for the MSCI World sector), combined with weak relative returns (down 1% compared to flat), hurt results. Axis Bank (down 17%), Banco Santander (down 12%), and Itau Unibanco (down 9%) lagged.
- Additional detractors included Baidu (down 12%), Apache (down 11%), FedEx (down 11%), and Occidental Petroleum (down 10%).
KEY CONTRIBUTORS TO RELATIVE RESULTS
- Strong returns in the Health Care sector (up 4% compared to down 1% for the MSCI World sector), combined with a higher average weighting (17% versus 13%), had a positive impact. CVS Health (up 17%), Bristol-Myers Squibb (up 13%), GlaxoSmithKline (up 8%), and Sanofi (up 7%) performed well.
- Relative returns in the Communication Services sector (up 3% compared to up 1% for the MSCI World sector) and the Fund’s average overweight position (14% versus 8%) also helped performance. Altice Europe (up 45%), Grupo Televisa (up 16%), and Comcast (up 7%) contributed to results.
- Celanese (up 14%) and Societe Generale (up 8%) also contributed.
Y E A R - T O - D AT E P E R F O R M A N C E R E V I E W
The Fund underperformed the MSCI World Index by 5.8 percentage points year to date.
KEY DETRACTORS FROM RELATIVE RESULTS
- Weak returns from holdings in the Financials sector (up 8% compared to up 15% for the MSCI World sector) hurt results. Societe Generale (down 8%), Banco Santander (down 8%), and UBS Group (down 3%) lagged.
- The Fund’s average underweight position in the Information Technology sector (10% versus 16% for the MSCI World sector), combined with weak relative returns (up 18% compared to up 30%), hurt results. Juniper Networks (down 6%) detracted.
- Additional detractors included Qurate Retail (down 47%), Baidu (down 35%), Occidental Petroleum (down 24%), and FedEx (down 9%).
KEY CONTRIBUTORS TO RELATIVE RESULTS
- Strong returns in the Materials sector (up 21% compared to up 14% for the MSCI World sector) had a positive impact. Celanese (up 38%) and Linde (up 24%) performed well.
- Relative returns in the Communication Services sector (up 19% compared to up 18% for the MSCI World sector), combined with a higher average weighting (15% versus 8%), had a positive impact. Altice Europe (up 169%), Zayo Group (up 48%), Charter Communications (up 45%), and Comcast (up 34%) were strong performers.
- Additional contributors included Anadarko Petroleum (up 64% to date of sale), Johnson Controls International (up 51%), and JD.com (up 35%).
1 The Fund’s total returns include the reinvestment of dividend and capital gain distributions, but have not been adjusted for any income taxes payable by shareholders on these distributions or on Fund share redemptions. Index returns include dividends but, unlike Fund returns, do not reflect fees or expenses. The MSCI World Index is a broad-based, unmanaged equity market index aggregated from 23 developed market country indices, including the United States and Canada. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. All returns are stated in U.S. dollars, unless otherwise noted.
2 Value stocks are the lower valuation portion of the equity market, and growth stocks are the higher valuation portion.
3 The MSCI World Growth had a total annualized return of 176.1% from September 30, 2009 through September 30, 2019 compared to 102.2% for the MSCI World Value.
4 Unless otherwise specified, all weightings and characteristics are as of September 30, 2019.
5 The MSCI EAFE trades at an attractive valuation of 13.7 times forward earnings, versus the S&P 500 at 17.5 times.
6 The Dodge & Cox Global Stock Fund had a cumulative total return of 129.3% from September 30, 2009 through September 30, 2019 compared to 102.2% for MSCI World Value, 123.0% for the MSCI ACWI, and 136.9% for MSCI World.
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. Fund performance changes over time and currently may be significantly lower than stated above.
