Global Equity Strategy—2024 Semi-Annual Investment Review

Chad: Hello everyone. Thanks for listening to Dodge & Cox’s Mid-2024 Review of the Global Stock Fund. My name is Chad Musolf, and I’m a member of Dodge & Cox’s Client Service team. And joining me today is Karol Marcin, a 23-year veteran of our firm and a member of the [Global Equity Investment] Committee that manages the Global Stock Fund. Welcome, Karol.

Karol: Thanks, Chad. Great to be here.

Chad: Over the next 20 minutes or so, we’ll provide an update on global equity markets. We’ll cover the Fund’s performance and attribution, and then, finally, we’ll highlight our current positioning and where we’ve been finding opportunities. But before we get into too much detail, Karol, perhaps you could share any key messages you want investors to take away from today’s discussion.

Karol: Yes—thanks, Chad. There are three things I would like to leave with our investors today. Number one, we are excited about our current portfolio, which is diversified across geographies, sectors, and investment theses. Number two, we remain focused on attractively priced stocks where we expect to benefit from growing earnings and improving valuation over time. And number three, we have faced the twin headwinds of value stocks¹ underperforming growth stocks and international stocks underperforming U.S. stocks. Any moderation in either of these two trends would be an additional tailwind to our portfolio.

Chad: Well, that’s really helpful, Karol. Thanks. Let’s now turn to our first agenda item by reviewing what’s been going on in global equity markets. Karol, you just mentioned a couple of market dynamics that continue to influence our relative performance, namely growth versus value and U.S. versus non-U.S. But what other market developments do you think are helpful context for the Global Stock Fund?

Karol: Slide five summarizes the recent market developments. On the upper left, we segment the global markets geographically. You can see that year to date, so combining quarter one and quarter two, all regions are up. You can also see that markets can change quickly. Japan was the clear winner in the first quarter, but it was a laggard in the second. China was the only region actually down in 2023 and underperformed in the first quarter, but had the highest return in the second quarter. These sort of performance reversals happen, especially over shorter periods of time, which is why we feel that it is important to stay invested and to maintain a long-term investment horizon. Turning to the upper right, where we segment the markets by industry sectors, you can see that the market performance was driven by just a few sectors—Information Technology, Communication Services, and Utilities—while the remaining sectors were flat or down. Information Technology was the top-performing sector year to date and, since the Fund is underweight Information Technology^,2 the sector’s strong performance has been a headwind for us this year. On the lower left, we track inflation and interest rates. Declining inflation is good for the economy and for our portfolio. And the current moderate level of interest rates with the U.S. 10-Year Treasury yielding 4% is also favorable for our portfolio and, in particular, for our financial services companies, whose profitability was depressed by the low interest rates of the recent past. On the lower right, you can see that recession fears are easing across the major economies. Recessions are hard to forecast and this chart may not have a lot of predictive power, but market optimism is good for the economy and for our portfolio.

Chad: Let’s move on to the Fund’s performance and attribution. Page six shows the Global Stock Fund’s performance in the blue-shaded row followed by the MSCI ACWI [Index]³ and the [MSCI] ACWI Value [Index].⁴ And as a reminder, the primary benchmark is [MSCI] ACWI, but given our value orientation, we also show the [MSCI] ACWI Value. For the year-to-date period, Global Stock Fund has had solid absolute performance, but it did underperform both indices. And for those of you who benchmark the Fund against the broader [MSCI] ACWI, you’ll see that the Fund remains ahead of [MSCI] ACWI for the three-[year], five-[year], and since inception periods. And Karol is going to cover specific attribution against [MSCI] ACWI in a bit. But generally speaking, our Fund’s value orientation has been a headwind for the last couple of years, as has our underweight to U.S. equity, specifically mega-cap[italization]⁵ tech companies. And for those of you who compare the Fund to the [MSCI ACWI] Value, we note that despite underperforming year to date, Global Stock Fund is ahead of the [MSCI ACWI] Value Index over all other time periods. And as you may know, the Fund does hold several larger tech-related companies including Alphabet, Amazon, Meta, and Microsoft, whereas the [MSCI ACWI] Value Index does not. But, obviously, there’s a lot more to it than that. Karol, would you please walk us through some of the drivers of relative performance year to date?

Karol: Sure. So, let’s turn to page seven to look at our sector attribution relative to [MSCI] ACWI. Since we underperformed the Index year to date, let’s start with our detractors, which you can see towards the bottom of the page. The main detractors were our underweight position in Information Technology, our Health Care holdings, including CVS Health,⁶ Communication Services names, particularly Comcast and Charter [Communications], and our positions in XP and Akzo Nobel.

Chad: A common question we get about our detractors is whether or not we’ve been adding into weakness. Has that been the case this year, that we’ve been adding to our detractors?

Karol: Yes. Health Care has been our largest sector add year to date. We’ve added to several names in there, and our largest add was CVS Health. CVS Health is experiencing higher-than-expected claims in its Medicare Advantage business. We expect that over time, policy pricing and reimbursements will catch up with claims costs, which should lead to margins recovering from a cyclical low. CVS is trading at eight times earnings.

Chad: And you also mentioned Charter and Comcast were detractors. What’s been going on with them?

Karol: Comcast and Charter are suffering from increased competition from fiber overbuilds and growth in fixed wireless broadband, which have pressured their subscriber trends. In addition, Charter has increased its capital spending, which will pressure its ability to return cash to shareholders in the near term. But we think that competitive pressures are probably peaking right now, and there are positive developments as well, such as growth in cable wireless product. Both companies are trading at very attractive valuations. Considering all of the above, we have been adding to Charter.

Chad: It sounds like we still have confidence in these areas of our portfolio and the names in in these areas, so really appreciate that confirmation. And now could you talk a little bit about the contributors year to date?

Karol: Happy to. Our key contributors year to date were stock selection in Industrials, and then individual positions: Barclays, Coherent, and Alphabet. To again offer some color, let me touch on Barclays. Earlier this year, Barclays announced their new ROE (return on equity) target of 12%, which is above what they’re earning today, 9%. And they’ve also said that they would return 10 billion [British] pounds to their shareholders. That’s about a half of their market cap before they made the announcement. So those are all great news. The share price reacted strongly, and we took some profits.

Chad: How about Alphabet? Perhaps talking a little bit about what’s happening with the company and then, given we’re a value-oriented manager, why it’s in the portfolio in the first place?

Karol: Starting with the performance, Alphabet has outperformed year to date on accelerating revenue growth, on the back of recovering digital advertising market, increasing margins due to strong cost control, and few positive data points on the integration of Gemini into search. Speaking of Alphabet, the company traded at the upper end of our portfolio range of valuations. However, considering the extraordinary strength of their businesses and their growth prospects, we think that is actually attractive. So, while most of our investments tend to trade at low absolute valuations, we are willing to consider higher valuations when the fundamentals support that.

Chad: Yeah, that’s a good point. I think Alphabet is also a great example that even some of the best companies in the world experience some sort of controversy that provides a reasonable entry point. Thanks for walking us through those performance drivers and for highlighting a couple of examples of how we make adjustments to our holdings based on their ever-changing valuations.

I want to switch gears now to talk about how we’re positioned and where we’ve been finding opportunities this year. Let’s start by looking at our current positioning. On page eight, towards the top of this page, you’ll see our sector weights in brown and the indices’ weights in blue. Going from left to right, you’ll see our largest sector weights followed by our smallest weights. The table at the bottom left shows some key characteristics of the Fund relative to the indices, where our value orientation is pretty clear, and then the wheel chart at the bottom right shows our geographic diversification.

Just stepping back for a second, I want to remind our listeners of a couple of key points. The first is that we’re building our portfolio company by company and our weights and characteristics are an outcome of that individual stock selection process. And then the other aspect to remember is that this page looks fairly similar from one quarter to the next and even one year to the next. And that’s because our [portfolio] turnover⁷ is generally low and, oftentimes, we’re just adding and trimming at the margins. And because these high-level exposures have persisted, perhaps it makes sense, Karol, for you to discuss our key overweights and underweights.

Karol: Our largest allocations and our largest overweights relative to [MSCI] ACWI are Financials and Health Care. This has been a case for a while, as you said, Chad, and there are a few things to keep in mind here. In both of these sectors, we actually have a large variety of investment themes. So, in Financials, we have exposure to cheap, developed market banks, emerging market banks that should benefit from growth in financial inclusion around the world, financial IT (Information Technology) services firms, capital markets, and insurance. Similarly, in Health Care we have exposures ranging from pharma through biotech, health care services, equipment, and supplies, all the way to life sciences tools. We are continuously tweaking and adjusting our portfolio, responding to changes in valuation and in fundamentals. In the most recent quarter, we have been trimming our strong-performing developed market banks, and we have been adding to Health Care, but as you said, Chad, the overall position of the portfolio is very much consistent with the last few times we’ve reported.

Chad: We also have the large underweight to IT (Information Technology), more so compared to [MSCI] ACWI, but we’re still underweight compared to [MSCI] ACWI Value too. What are your thoughts on that underweight?

Karol: As we just discussed when we talked about Alphabet, we are willing to look at companies that trade at higher absolute valuations, but we always compare those to what we believe are the underlying fundamentals. We were able to establish positions in several large tech companies. Overall, and on average in this space, though, we are finding that in many instances the valuation is well ahead of what we would consider to be fundamentals, and in our opinion, it’d be difficult to get a competitive return from a lot of these positions. With that, we ended up with an underweight in Information Technology.

Chad: Certainly makes sense. And I think the other noticeably large underweight in the portfolio is our allocation to U.S. equity. I’d love to hear the Investment Committee’s thoughts on that continued underweight to the U.S.

Karol: So, just trying to think about how we invest, looking for the right balance of value and fundamentals. The fact that the U.S. stocks are more expensive than the international stocks would make one think that we should be finding more opportunities abroad, but in fact, we actually have been increasing our allocation to the U.S. It’s just that in our benchmark, the U.S. weight has been increasing even faster than in our own portfolio, and so this underweight has been increasing over the last few periods.

Chad: And that’s key insight we’ve been adding there, but the underweight relative to the benchmark looks like it’s growing based on what’s happening with the [MSCI ACWI] benchmark. To bring it back to my earlier comment, I just wanted to mention that I think it’s helpful in keeping these larger relative weights in mind because they do provide insight on our relative performance, both historically and then also going forward. Just as I mentioned before, these exposures are really a residual of our bottom-up process, so it likely makes sense to talk more about that. We have been finding opportunities across the board so far this year. Karol, would you walk us through some of the newer additions in the portfolio?

Karol: We had nine new buys in the last six months. We are finding new opportunities across many sectors, including Industrials, where we started positions in Ashtead, Daikin, and DHL [Group]; Health Care: Humana; e-commerce: Coupang; and Energy: BP. We bought our first utility, AEP, and we even found an opportunity in Semiconductors where we started a position in Infineon [Technologies].

Chad: Yeah, that last one is pretty interesting, especially since the broader Semi[conductors] industry has done so well lately. Maybe you can talk a little bit more about Infineon and how it fits into a value-oriented portfolio.

Karol: Global Semiconductors [industry in the MSCI ACWI] Index trades at 29 times [forward] earnings, but we bought Infineon at 17 times. Infineon is a leading semiconductor company serving auto and industrial markets, and those markets are currently experiencing elevated inventory levels. So, as the markets are clearing the inventory, there is uncertainty about where is the right level of Infineon sales and profits, and that’s pressuring the valuation. We believe that after the inventory [has] cleared and the markets [have] stabilized, Infineon will resume revenue and profits growth, and we should see improved valuation on top of that.

Chad: I’ll just quickly add that Infineon is also a pretty good example of our bottom-up approach in that our analysts are actively searching for, and many times finding, new opportunities in their areas of coverage even if the particular industry or sector or country that they’re covering appears overvalued.

Karol: That’s exactly right, Chad.

Chad: You mentioned we added a utility this year. That’s certainly new for the Fund. American Electric Power (AEP)—tell us about that.

Karol: AEP is the largest owner-operator of U.S. power transmission grids. Two thirds of their earnings come from transmission and distribution and one third from power generation. We expect AEP to benefit from growing power demand, from the upgrades and growth of its grid, and we expect to see improving ROE for all this. We’re only paying 15 times [forward] earnings.

Chad: That’s great. What about the names we’ve sold? Can you talk about those, please?

Karol: We sold seven names this year. Typically, our sales are companies where we observed improved results, which were rewarded by higher valuations, such as names like Ovintiv, ICICI Bank, or T-Mobile. ICICI’s valuation has increased relative to other Indian banks. In fact, the share price has tripled since 2020. We have sold our position in ICICI and funded a new position in HDFC [Bank]. Now, HDFC is also an Indian bank. Historically, HDFC traded at a premium to ICICI, but while ICICI’s execution has improved, and its valuation has increased, HDFC’s valuation has declined over the disappointing results following a large merger. But HDFC is still exposed to the same long-term, favorable trends in Indian banking as ICICI is, and we think that in owning HDFC, you should benefit from those and further from the upside from the merger synergies, which we still think will come through.

Chad: Despite low turnover generally for the Global Stock Fund, there’s still a lot happening under the hood, so to speak. It’s also great to hear that we’ve been finding opportunities across the board. I really appreciate your thoughts on positioning, Karol, and where we’ve been finding opportunities. Any closing remarks you’d like to make?

Karol: First of all, I’d like to thank everyone for your interest in the Dodge & Cox Global Stock Fund, and for listening to our audiocast. I would like to close with the same three points I made at the outset of our call, which are number one, our value orientation and underweight in the U.S. have been headwinds; number two, we continue to focus on finding stocks with attractive valuations that we expect will benefit from earnings growth⁸ and improved valuations over the long term; and in conclusion, we are very excited about our current portfolio, which is diversified across geographies, sectors, and investment theses.

Chad: Thanks again, Karol, and thanks to our listeners as well. We’re grateful for your continued confidence in Dodge & Cox and the Global Stock Fund. If you have any questions, please reach out to your Dodge & Cox contact. Thanks again and have a great day.