Dodge & Cox's Troubles with Financials
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Thursday, January 08, 2009

Dodge & Cox's Troubles with Financials

The bloom is off the rose at Dodge & Cox. Kiplingers takes a look at the once high-flying, San Francisco-based value manager's recent slide, contrasting it with another rough patch that ran from 1995 to 1999.

How bad has it been at the fund firm? Well, Dodge & Cox Stock was off 46 percent through the end of November, trailing the S&P 500 by roughly 700 bps.

Kiplingers claims that this current underperformance is "more painful" than that in the second half of 1990s as it stems from a "sin of commission" (losing money in financial stocks) rather than a "sin of ommission (failing to bet on tech and other growth stocks, which is actually part of Dodge & Cox's business plan).

The article also delves into how Dodge & Cox's "collegial and consensus driven" investment process ended up placing the firm's funds heavily in financial stocks. One source blamed its "left-brained Harvard and Stanford graduates."

John Gunn, Dodge & Cox's chairman, told the magazine that historically financial stocks have performed well following periods of duress and distressed stock prices. He and Ken Olivier, Dodge & Cox's president, point their finger at the government which reacted uniquely this time.

"The government by its actions destroyed capital in the financial institutions and discouraged private capital," says Gunn. "It threw gasoline on the fire."

The magazine, on the other hand, stresses Dodge & Cox's blindness to systemic risk rolled up in a worst-case scenario, alluding to Nassim Taleb's so-called "black swans."

Another way to explain Dodge & Cox's blind spot is to go back to probability theory and statistics. On a bell curve of potential outcomes, the firm failed to recognize the statistical outliers -- possible but improbable events that can be hugely disruptive and destructive if they occur.

Still, the magazine in the end recommends the funds even today. "This is a fine, proud, high-quality company populated with competitive and serious high achievers who have heavily invested in their own funds. They will learn from their investing mistakes," it notes while adding that "The firm's long-term record is outstanding, the investment process has worked, and the institutional memory is strong.

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