Dodge & Cox Stock (ticker symbol DODGX) is a mutual fund with approx. $42.9 billion in total net assets managed by John Gunn and associates. Currently, Morningstar rates the fund Three Stars / Gold in the US OE Large Value category. The latest Morningstar report on the fund, titled “Shareholders need to share management’s patience” was published in October 2012. At present, this no-load fund has a total expense ratio of 0.52% and sports a low 11% portfolio turnover rate. Let’s evaluate the fund’s performance using the Alpholio™ methodology.

First, the total return chart, which assumes reinvestment of all distributions into the fund and each member of the reference portfolio, respectively:

Cumulative Return of DODGX and Reference Portfolio

The chart demonstrates that from early 2005 to late 2007, the performance of the fund was generally matched by that of its reference portfolio. Subsequently, the fund underperformed.

This is further illustrated by the cumulative RealAlpha™ chart:

Cumulative RealAlpha™ for DODGX

In the chart, the lag cumulative RealAlpha™ curve overlaps, for the most part, the regular RealAlpha™ curve from 2005 through 2008. Typically, this is an indication that the fund managers did not make any major directional bets that significantly departed from the fund’s holdings in the immediately preceding time window. From 2009 onwards, this approach changed; however, the net result was an undesirable downward trend of the cumulative RealAlpha™. In addition, in that period the lag RealAlpha™ curve was below the regular RealAlpha™ curve, which implies that some of the managers’ bets backfired – the investor would be better off sticking with the frozen reference portfolio (see FAQ).

The overall statistics further underscore the unimpressive performance of the fund, esp. in the latter part of the analysis period:

DODGX Statistics

At about 18.5%, the fund’s volatility, measured by an annualized standard deviation of monthly returns in the entire analysis period, was slightly higher than that of the overall stock market. The volatility of the reference portfolio was slightly lower than that of the fund. This typically indicates that the fund was well diversified and contained positions generally present in the reference exchange-traded products (ETPs). The discounted annualized RealAlpha™ of the fund was approx. negative 1%, which was mostly caused by a significant loss of alpha since 2008. At about 1.05, the fund’s RealBeta™ was slightly higher than that of the market, which was also reflected in the elevated volatility.

The following chart demonstrates the use of smoothed RealAlpha™ to automatically generate a hypothetical trading signal for the fund:

Buy-Sell Signal for DODGX (Smooth)

The analysis starts with an assumption that the investor initially bought the fund in early 2005 and intended to hold this investment indefinitely, i.e. at least through early 2013. The blue curve depicts the cumulative RealAlpha™ in that entire period. Since there is some degree of high-frequency oscillation in that curve, its longer-term trend can be elicited from its smoothed approximation, depicted by the green curve. Subsequently, a simple decision criterion is applied to determine whether the investment in the fund should be retained. As long as the fund generates positive monthly increments to cumulative RealAlpha™, the investment in the fund is considered beneficial. Conversely, if the fund’s cumulative RealAlpha™ begins to consistently decrease, the investment is no longer considered attractive.

The signal would allow an investor to avoid the two long periods of the fund’s underperformance according to the smoothed RealAlpha™ measure. Please note that there is not guarantee that the recent positive trend in cumulative RealAlpha™ will continue to sustain a buy signal.

The following chart shows the major investment “themes” of the fund over time:

Reference Weights for DODGX

In the analysis period, the fund held equivalent equity positions in OEF (iShares S&P 100 ETF; average weight of 20%), RSP (Guggenheim S&P 500® Equal Weight ETF; 14.2%), VFH (Vanguard Financials ETF; 11.6%), VCR (Vanguard Consumer Discretionary ETF; 10.3%), IXJ (iShares Global Healthcare ETF; 9.9%), and VHT (Vanguard Health Care ETF; 7.3%).

For clarity, smaller reference positions are collectively represented by the Other category in the chart. For example, this category includes an equivalent position in VDE (Vanguard Energy ETF; average weight of 5.7%).

Unlike others, this mutual fund did not exhibit an equivalent cash position in the analysis period. This indicates that the fund generally avoided building substantial cash reserves in an effort to time the market, and instead continuously favored equity holdings. This is what most investors in the fund would certainly appreciate.

While the Morningstar analyst report says that

“Persistence pays off for Dodge & Cox Stock.”

this analysis clearly demonstrates that the strategy of the fund could easily be replicated using a fairly small number of exchange-traded products (ETPs), and with a better performance (higher return with lower volatility). Investors could use the results of the ongoing Alpholio™ analysis to construct a dynamic substitute portfolio of liquid, low-cost instruments that provide a better diversification than the fund does (75 stocks at the latest regulatory filing).

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